How to build a diversified liquid fund portfolio?

Wondering how to invest in mutual funds without taking on too much risk, and having the flexibility to access your funds quickly? Liquid funds could help here.

A liquid fund is a type of debt fund that invests in short-term financial instruments like treasury bills, certificates of deposit, commercial paper, etc., that mature within 91 days. The primary objective is to provide liquidity, safety, and reasonable returns. Many investors opt for liquid funds as they offer higher liquidity and allow them to easily park their money in a safe and accessible way without having to worry about locking in their funds for an extended period.

While liquidity is a crucial factor, it should not be the only consideration when building a liquid fund portfolio. Diversification is as important to maximise your liquid fund investment returns. With that being said, take a closer look at how to build a liquid fund portfolio that balances both liquidity and diversification.

1. Choose a mix of fund houses

One way to ensure that your liquid fund investments are diversified is to pick mutual funds from different fund houses. By choosing funds from different asset management companies, you can reduce the risk of your investments. This is because every fund house has a different style of fund management, and every fund house responds to market changes differently. Thus, by investing in multiple fund houses, you can avoid the risk associated with a single fund house.

2. Invest in different types of debt instruments

T-bills, government bonds, commercial paper, and certificates of deposit are some of the debt instruments that liquid funds invest in. If you want to build a diversified portfolio, invest in otherdebt fund types as well. This will help to hedge the risks of a single investment as a diversified portfolio is more likely to offset any underperformance of a specific asset, making it the best way to invest in liquid funds.

3. Consider portfolio allocation and invest in multiple liquid funds

Consider investing in multiple liquid mutual funds that have different portfolio allocations and invest in different instruments. For example, you may choose a fund that invests a higher percentage in government securities, while another may invest predominantly in corporate bonds. Spreading investments across multiple funds will ensure there is no concentration risk in your portfolio, and you earn stable returns.

4. Invest in liquid funds with higher credit ratings

Always read the scheme information document available on the websites of the respective fund houses, which contains detailed information about the fund’s investment objectives, guidelines, past performance, risk factors, and other important points.

Most importantly, you can check the fund’s credit rating, as debt funds’ credibility also depends on the creditworthiness of the fund’s underlying investments. By selecting funds with a higher credit rating, you can manage the fund’s risk profile with high-quality investments.

Final words

With features like instant access facility, less risk, and steady short-term income, liquid funds can be a worthwhile addition to your portfolio for various financial goals. However, besides liquid funds, it is also wise to invest in different asset classes that fit within your personal risk and return objectives. These may include stocks, real estate, commodities, and othermutual fund investments. Because various asset classes perform differently over different market cycles, diversifying between them can help you balance your investments.

Additionally, it’s important to consult with a financial expert periodically to ensure that you invest in a strategic way to meet both your short and long-term goals.

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