Liquidity in Mutual Funds: A Complete Guide

You can build an ideal portfolio by investing in schemes with a balanced outlook on the risk, income potential and liquidity in mutual funds. The latter plays a large role when you have unplanned financial requirements or react to market dynamics that require you to buy or sell units immediately. 

Read on to know the meaning of liquidity, its role in mutual fund investments and more.

What is Liquidity?

In finance, liquidity plays a very important role in deciding if the asset is worth investing in. It refers to the duration and expense required to convert the investment into cash. This is because a highly liquefiable asset gives the opportunity to dissolve your investment in case of any emergency. The need for liquidity is impacted by your risk appetite, as you may want to withdraw your funds to protect your portfolio from losses.  

Any asset that you can easily sell has high liquidity. For example, retirement plans, government bonds and tax-saving Fixed Deposit have low liquidity. This is because they come with a fixed lock-in period before which you cannot withdraw your funds. On the other hand, money market investments, treasury bills, gold and stocks of popular companies have high liquidity. You can easily sell them anytime without much hassle. 

Why Does Liquidity Matter in Mutual Funds? 

Understanding mutual fund liquidity is important since it plays a crucial role in balancing risk and returns. Here are some reasons why you should consider the liquidity in mutual funds before investing.

• Risk Assessment 

Generally, mutual funds with low liquidity come with higher risk. This is because you do not have the option to sell the asset quickly and without causing a significant price change. Close-ended schemes and fixed maturity plans are not as liquid and may be harder to redeem when you want to exit. 

• Total Returns 

You also have to pay an exit load on selling your mutual fund units. You may face a loss if you liquidate your investment when the market is on a downswing. Considering liquidity enables you to make timely decisions about buying and selling your asset to align with your investment goal and current needs. 

• Quick Redemption 

With high liquidity in mutual funds, you can enjoy hassle-free and fast redemption. So, you can exit without much delay or facing losses. 

• Credibility of the Funds

Since highly liquid mutual funds allow you to manage your portfolio with ease, they attract more investors. This also contributes to a trustworthy investment that is likely to offer stable returns over a long period. 

• Investment Horizon 

The liquidity of the mutual funds also depends on how long you can stay invested. Short-term funds have high liquidity but low returns. On the other hand, long-term options have better returns with low liquidity. Keeping this in mind, you can make the right decision as per your long-term and short-term objectives. 

Factors to Consider

If you are looking for liquidity in mutual funds, keep the following factors in mind. 

• Firstly, assess your risk appetite and choose a liquid fund if you have a low tolerance for risk  
• Opt for a fund with a low exit load
• More liquid schemes are usually:
  • Money market securities
  • Large-cap mutual funds
  • Government bonds 
• A highly liquid fund is one where you can buy and sell units without impacting their market value in any significant way 
• More commonly traded funds are more liquid 
• Professionals who manage schemes offer liquidity by considering:
  • Dividends
  • New purchases of liquid investments 
  • Managing the inflow of cash 

Now, what if your mutual fund liquidity is low? In that case, you can apply for Fibe Loan Against Mutual Funds. With this offering, you can pledge your mutual fund as collateral to get up to 80% of its value up to ₹10 lakhs.

This way, you don’t need to liquidate your assets and you can continue your investment. Simply check your eligibility, submit the essential documents and get the funds in your account. Download the Fibe App to meet all your urgent financial requirements while increasing your potential for capital gains. 

FAQs on Liquidity in Mutual Fund

How does the Locking period in MF affect liquidity?

Lock-in periods are useful to provide stability and higher returns. However, they may reduce the liquidity of the investment as you cannot withdraw the amount before the designated period.

How can I check the liquidity of a specific mutual fund?

To measure the mutual fund liquidity, you can review its cash ratio and the fund’s document. You can also analyse the performance report to check its average daily volume to understand how frequently investors buy and sell this mutual fund.