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Debt funds: Liquid versus liquid plus | September 15, 2008 14:33 IST

Being financial planners, we regularly interact with investors to understand their needs and the problems they face while investing. And more often than not, their concern about debt instruments is unanimous.

While most investors appreciate the importance of investing in debt (like debt funds, for instance), the lack of knowledge about debt instruments and their complicated nature, prevents them from venturing into this segment.

Moreover, the jargon associated with debt instruments can be confusing for the average investor. That explains why debt investment remains a mystery for a majority of investors.

Debt-oriented mutual funds provide investors a convenient way of investing in debt markets. There are also various categories of debt funds catering to the needs of various investors.

However, due to the reasons cited above, many investors fail to understand the difference between these categories.

Among them, liquid and liquid plus funds are the most misunderstood ones. At Personalfn, we receive queries from investors curious to know how these two categories differ from each other or if there is any difference at all. This note aims at addressing these queries.

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While both liquid and liquid plus funds are short-term debt funds, they are different in a few aspects.

1. Investment tenure

This is the major differentiating factor between liquid and liquid plus funds. The debt instruments held by liquid plus funds have a longer tenure than liquid funds i.e. the portfolios of liquid plus funds have a higher average maturity than those of liquid funds.

In effect, while investors can invest in liquid funds for as briefly as one day, the holding period for liquid plus funds should be higher than that.

2. Exit load

Both liquid and liquid plus funds can be redeemed within a day. However, if liquid plus funds are redeemed within a specified period, there can be an exit load (the minimum investment tenure and the exit load varies across fund houses). On the other hand, there is no exit load on liquid funds.

3. Dividend distribution tax

Liquid plus funds are more tax efficient than liquid funds. In terms of tax implications, a dividend distribution tax of 28.33 per cent is charged on liquid funds, whereas it's 14.16 per cent for liquid plus funds (in case of individual investors).

Tax implications: Liquid vs other debt funds

(Other debt funds include liquid plus funds. Surcharge rate and cess have been factored in.)

4. Risk

Liquid plus funds are riskier vis-a-vis liquid funds. This is mainly due to two reasons a) liquid plus funds hold investments that have a higher maturity and b) there is no limit on the mark-to-market (MTM) component of liquid plus funds as opposed to the 10% MTM limit on liquid funds.

Apart from the above, there are some other points of distinction between liquid and liquid plus funds. For instance, liquid and liquid plus funds have varying market-to-market (MTM) components; they also have different cut-off timings for the present day's NAV.

What should investors do?

Investors would do well to take into account above-mentioned differences while investing in liquid or liquid plus schemes.

Investors who have a relatively longer investment horizon can consider investing in liquid plus schemes, provided they are ready to stay invested for the specified duration in order to avoid paying the exit load. Investors, for whom liquidity is top priority, should opt for liquid funds.

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