Building long-term wealth requires strategic investing across different asset classes that maximize returns adjusted for risk tolerance. A key piece of this portfolio construction approach is parking a part of your savings in liquid funds – one of the safest debt mutual fund categories.
In this post, we will first understand what makes leading liquid funds attractive investment vehicles. We then evaluate approaches to identify the best liquid funds for parking short-term surplus money. Finally, we discuss the relevance of CAGR or Compound Annual Growth Rate in assessing the performance of your mutual fund portfolio.
Table of Contents
Understanding Liquid Funds – Benefits and Working Mechanism
Liquid funds invest in very short term debt and money market instruments with maturity of up to 91 days. They provide returns in line with prevailing short-term interest rates while offering the highest liquidity among debt funds – withdrawals available on a T+1 basis.
Let’s see why parking a portion of your investments here may be prudent:
- Low-Risk Profile: The underlying ultra-short-term instruments have negligible default risk. Hence, capital preservation is high.
- Ideal Parking Avenue: You can park funds earmarked for near-term financial goals like emergency corpus, down payment for a house, etc. Redemption is available the next business day without exit loads.
- Tax Efficiency – Indexation benefits available on long term capital gains, making liquid funds tax efficient. Dividend options are also available for regular income.
So, liquid mutual funds offer a productive avenue for deploying money that needs to retain high liquidity while aiming for better returns than traditional savings accounts.
Parameters for Choosing the Best Liquid Fund
While liquid funds have no or low duration or credit risk given the underlying investments, the category has evolved with different plans now available. The best liquid funds remain focused on minimizing portfolio risk while maximizing returns through rigorous investment processes.
Let’s examine what parameters you should assess to pick the best liquid fund for you:
- Returns Consistency – Opt for a fund with a consistent track record of beating benchmark returns across market cycles. Avoid outliers.
- Fund Manager Tenure – A higher tenure of over 5 years ensures fund management stability and steady performance.
- Assets Under Management (AUM) – Look for a larger AUM of over ₹10,000 crores, implying wider investor trust.
- Expense Ratio – Go for a lower expense ratio below 1% p.a. This reduces costs, impacting net returns.
- Portfolio Credit Quality – Look for funds that maintain an average portfolio credit rating of A+, ensuring safety.
Thus, analyzing the 5-year performance record, fund manager experience, AUM size and costs allows you to pick an enduring liquid fund for parking short-term money goals.
Significance of CAGR for Your Mutual Fund Portfolio
What is CAGR in mutual funds? It captures consistency in a fund’s ability to compound money year-on-year, factoring in interim volatility periods. While liquid funds deliver stable returns aligned to short-term rates, assessing the performance of your market-linked equity funds requires the important CAGR metric tracking long-run value creation.
Let’s understand why focusing on CAGR or compound annual growth rate is vital:
1. CAGR Captures Steady Return Creation Over Time
Unlike point-to-point returns, CAGR smooths out intermittent volatility, capturing consistency of return generation annually. For equity funds, a long-term CAGR of over 12% signifies healthy growth.
2. CAGR Adjusted for Inflation Indicates Real Return
The nominal CAGR should be above inflation by a suitable margin for wealth increase in real terms. Target CAGR over inflation of 5% ensures doubling investment value every 10-12 years, approximately factoring in the inflationary effect.
Thus, focusing on CAGR more than short-term point returns allows assessing if your equity investments are truly aligned for creating the required growth momentum over full market cycles.
Best Practices for Boosting Portfolio CAGR
Follow these research-backed guidelines to improve your chances of achieving 15%+ CAGR on your equity mutual fund investments over the long run:
- Allocate Among Categories – Spread allocation across large-cap, midcap, multi-cap, and thematic funds, capturing diverse market opportunities.
- Prefer Value Style over Growth – Value style funds that pick undervalued stocks have been shown to deliver higher risk-adjusted returns over decades.
- Maintain International Exposure – Allocate 10-15% to international funds, providing diversification and tapping global growth potential.