Introduction to Equities, Debt funds and Liquid Funds – For beginner investors

POSTED BY manish ON November 13, 2008 COMMENTS (75)

We will talk about Equity, Debt and Liquid Funds. We will also discuss dividend distribution tax is treated for all these funds.

mutual funds

First understand what is DDT (dividend distribution tax)

Dividend received from a mutual fund is tax free, but only at receivers hand. But mutual funds have to pay a tax on that dividend to Govt before giving it to us. So actually the tax is paid by mutual fund on behalf of us. This tax is called DDT.

Now lets go ahead and see different types on Funds.

Equity Funds

They are the funds that invest more than 65% of their corpus in equity shares of companies. The dividend distributed by such funds is exempt from the dividend distribution tax. So all the dividend which is declared comes to the unit holders, you get 100% of dividends.

But don’t think that this is some extra income .. it is just a part of your own money, after you get the dividend, NAV comes down by that much. This is difference between growth and dividend funds. You actually got some money back, nothing else.

Dividends are are totally tax free and not even DDT is applied to it.

Why to invest : You should invest in Equity mutual funds when you want to invest for long term and when you can take risk. Understand that these funds invest primarily in Equity, so there is more risk, but if you are investing for long term and want capital appreciation to happen, these are the funds for you.

Debt Funds

These funds invest in medium-to-long term debt securities like government bonds and corporate bonds/debentures. The dividend from these Funds are subject to 12.5% Dividend distribution tax. The fund is also liable to pay a surcharge and a cess of 10% and 3%, respectively, on the tax. The effective tax rate comes to 14.16%.

Why to invest : They are debt products and offer good liquidity also. If you want to invest some money for safe returns and for short term goal, then Debt funds are something you can look at.

Liquid Funds

These invest in short-term debt securities (which have a duration of less than a year) like commercial papers, certificates of deposit and call money. The income distributed by such funds is subject to an income distribution tax of 25%. The fund is also liable to pay a surcharge and cess of 10% and 3%, respectively, on the tax.

The effective tax rate for liquid and money market funds is 28.32%.

Why to invest : The main reason for investing in Liquid funds should be Liquidity factor, these funds are most liquid and least volatile .. So if you need to have liquidity in your portfolio, always invest some money in Liquid funds, any extra money lying in your Saving Account above your 1 month requirement should be in Liquid fund.

Conclusion :

There are different type of funds and they all have different purpose, you should see which one suits you and accordingly invest in that. Dividend received from mutual funds are not any extra money like Stock dividend. It is your own money.

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75 replies on this article “Introduction to Equities, Debt funds and Liquid Funds – For beginner investors”

  1. Arora says:

    Hi Manish,

    I want to buy some Liquid Funds in SIP format and have shortlisted following Liquid Funds based on reviews from Internet. My objective are Low Risk, Medium Term investment (2-3 years) with Less Taxes.

    – HDFC Liquid Fund (G)
    – UTI Liquid Fund – Cash Plan – Institutional (G)
    – L&T Liquid Fund – Super Institutional Plan (G)

    Please suggest If they are fine in my case or I should go with some other option.

    Please also suggest if I should buy it through my ICICIdirect demat account or direct/online from HDFC/UTI fund house. As one of my friend was saying ICICIdirect has some extra charges on top of it. Kindly let me know if ICICIDirect have some extra charges for buy/sell/manage Funds or it’s same as buying direct from Fund house.

    Thanks,
    Arora

    1. Yes, ICICI direct has extra charges per SIP . We use a platform for our clients who can do it without extra costs.

      If you are interested, please fill in http://www.jagoinvestor.com/solutions/invest-in-mutual-funds

  2. Nitu says:

    First can you explain me about debt fund and liquid fun. I want to invest in debt fund.
    Can you suggest best performing debt funds?

    1. Is it not already explained in the article ?

  3. Akhilesh says:

    I want to save 50000 per month and want to withdraw total amount after approx. 1 years for some specific purpose. Please suggest me best suitable type of debt fund from taxation and return point of view. I am in tax bracket of 30%. Please advise.

  4. Nilesh says:

    Hi I have around 15 L in my NRE Bank Account & will not need that money for 14 Months at least ( May be 24 Months as well) Please suggest various Tax free Safe instruments.

    1. In that case you can invest in Arbitrage funds , they are tax free after a year, treated exactly like a equity fund for taxation, but they are safe like equity funds.

  5. anilmegur says:

    Hi,
    I have lumpsum of around 10 lacs , I don’t want to do FD as its interest is taxable & also I am investing in Equity MF through SIP, so don’t want to invest more into that. I want to invest in debt mutual fund with least risk.Kindly suggest whether gilt long term fund is better orincome funds?

    1. Income funds are surely a very good option. You can go for them

  6. ravi says:

    I want to invest rs. 2000 each month for one year. after one year I want to withdraw all money alongwith return for some purpose say for visit to some tourist place. which type of mutual fund I should invest in which can give me maximum return with minimum risk?

    1. FD is the best choice in your case !

      1. ravi says:

        thank you manish for such a quick advice. but I have a doubt, how can I make a FD (Fixed Deposit) of rs. 2000.00 each month.

        1. ravi says:

          or it should be RD (recurring deposit) of rs . 2000.00 each month. is return of RD is more than debt mutual fund.

          1. It does not work like that, FD interest can be higher or lower than debt funds depending on the performance of debt fund. But in general debt funds offer better return because of the way its taxed

            1. ravi says:

              Thank you, manish. Now, I think I should bifurcate rs. 2000.00 in two instrument. one RD of rs. 1000.00 p.m. for one year. and one SIP of RS. 1000.00 p.m. for one year in debt mutual fund. and after one year I should with draw the total amount in RD and debt mutual fund to meet the purpose. is there any exit load and tax if I withdraw the total amount of debt mutual fund invested through SIP after one year in lump sum?

            2. Ravi

              seems like a good idea . Regarding exit load – yes some funds might have the exit load before 1 yr, please check that before you invest

            3. ravi says:

              Thank you, Manish.

        2. If you want to invest per month automatically, then you can just go to online banking and create online RD , or visit branch for it !

  7. Dilip says:

    Great Site. 🙂 Very useful.

  8. Chaitanya says:

    I want to keep about 3lacs in liquid fund. I would be redeming 50 to 60 thousand weekly and again repurchasing 50 to 60 thousand on and off in the same liquid fund. Which option should i opt for (Growth, Devidend, reinvestment). kindly reply

    1. I suggest growth option only

  9. Pingback: Liquid fund
  10. Vishal Jain says:

    I want to understand the difference between PPF and debt mf. These both provide almost fixed returns. Liquidity in case of PPF is very rigid. But it provides tax benefit in investment. Return is around 8 %. Is debt / debt oriented mf is better than ppf, if tax benefit on investment is ignored? But there is tax on withdrawl and interest in case of debt funds. Can SIP be done in debt / debt oriented mf? If yes can you suggest some good ones.

    1. Vishal

      your definition of “good” has to be defined by you only . Its like this, PPF and Debt MF are two kind of investments options with their own features. Now only you can tell if they fit your requirement or not .better you give your scenario and what you want to achieve

  11. Vishal Jain says:

    My annual income is around Rs. 10 lacs. I am 26 yrs old. I have 2 SIP in equity of Rs. 5000 each. I also have adequate life cover through term plan. I want to understand the difference between FD, PPF and debt mf. These all provide almost fixed returns. Liquidity in case of PPF is very rigid. But it provides tax benefit in investment. Return is around 8 %. Is debt / debt oriented mf is better than ppf, if tax benefit on investment is ignored? Can SIP be done in debt / debt oriented mf? If yes can you suggest some good ones.

    Thanks & Regards

  12. saravana says:

    I want to say for a downpayment (target 2-3 yrs) .I dont have bulk amount and can do monthly savings.Which is better long term bank RD or debt funds like dynamic bond fund .Please advise .

    1. RD will suit you better

  13. Poonam says:

    Hi,

    Firstly, really useful & informative blog !
    I wanted to know in a liquid fund – what is the difference in return if you opt for dividend reinvestment plan – weekly/monthly/daily ? Does it have any significant variations?

    Thanks

    1. There is no difference, just that the dividend will be reinvested ! , thats all !

  14. sorabh says:

    hi
    between debt funds and liquid funds which one to go for and why ? what i understood is there is no exit load on liquid funds after the lock in period, which can be as less as 7 days , where as in debt funds even if you exit after a year you need to factor the tax 10% or 20% with or without indexation.
    i need to know if i want to find a place to park my mf profits should i choose debt funds or liquid as i want to setup a stp from that new fund ( debt/liquid ) at some point.

    i wanted to add a stable component to my MF portfolio ( debt or liquid ) how to go about this ?

    1. Better setup the STP from debt fund then , liquid funds are mostly for liquidity purpose .

  15. Ranganath says:

    For ’emergency fund’ ( 3-6months entire expenses, including EMIs), which is the best place to keep ?
    Bank FD (7% per-yr rate) or liquid Funds ?

    Mainly looking for quick liquidity & zero risk to principal. (and if possible, keep-up with inflation, and lesser tax on returns )

  16. pranita says:

    Hi manish,

    I am new reader of your blog…really excellent information
    one q.
    it still not clear to me as to who pays the tax of 28.32%. on liquid funds..
    is it fund house who pays it or I have to pay during my yearly tax return ?
    and if I have my money in liquid fund growth option and I put it in that fund for more than 1 year then in that case what is the tax structure…

    1. Pranita

      Company will pay it

  17. Kaval says:

    Manish,

    You said that “the effective tax rate for liquid and money market funds is 28.32%.”
    how does this work?
    -Is it tax free in the hands of investor(but AMC pays for it from fund profit) ? OR
    – Investor has to pay it in yearly tax return ? OR
    – AMC pays it ?

    also, what is STCG and LTCG for liquid funds

    thanks in advance

    Kaval

    1. Kaval

      This is the tax you have to pay and its only for Short term , in long term , you can avail indexation benefits also.

      Manish

      1. Kaval says:

        thanks manish

        sorry to question you again. As I planning to park some money into liquid funds I would appreciate your help beforehand
        what I understood is that the profit from liquid funds needs to be taken care in that fiscal year tax return however i am thinking if someone comes under 20% tax bracket still he has to pay 28.32% tax on profit from liquid funds ? Can you please elaborate

        1. Kaval

          No , if you are in 20% tax braket , then the effective return is not lesser . Its just 20% , i was mainly talking about people in highest tax bracket , who also have to pay 10% and 3% of surcharges which makes their effective rate at 28.32%

          >>> 25 * (1.1) * (1.03)
          28.325000000000003

          Manish

          1. kaval says:

            thats quick reply from you 🙂

            I think, i got the point now.
            To summarize,
            if I choose the dividend option then I pay DDT which is 28.325 and if I choose this growth option I pay STCG

            1. Yes

              You pay tax on growth as STCG only before 1 yr , else its free 🙂

              Manish

  18. Avijit Sarkar says:

    Hi manish,

    My question is in mutual fund all we know apart from the principal amount whatever amount gained that is tax free in investor’s hand but whatever amount is investing by an investor are they tax free or taxable?

    1. Not sure what you are asking, profits in equity funds are tax free after one year only . Not before that .

      Manish

  19. Avijit Sarkar says:

    Hi Manish,
    first of all thank u fr ur reply, can u plz guide me what is debt and equity market? in mutual fund is there any fund which given a tax benefit of more than 100000/ per annum to investor ? if any customer switces his fund from liquid to equity/debt fund, is there any charges involved ???????

    1. To learn more on what is debt and equity markts , you have to read more , it cant be explained in comment section .

      Nothing gives more than 1 lac of tax exemption , there is no swtiching thing in mutual funds generally , you have to sell one and buy another, in which case there can be exit loads in some mutual funds before 1 yr

      Manish

  20. kamlesh says:

    manish,

    what is the different between liquid and liquid plus…any idea?

  21. avijit sarkar says:

    Hi manish,
    I’m little confused about liquid fund, so can you please briefly clarify me the basic differences between debt and liquid funds?? how does liquid fund is more convenient as comparason to bank recurring if any ????????

    Regards,
    Avijit

    1. Avijit

      Liquid funds are category of debt funds , which are liquid in nature , which means that you can liquidate your money faster in liquid funds compared to other kind of debt funds . debt funds are not convenient compared to bank RD ,just that they are more tax efficient, but bank RD are much simple to understand

      1. amol says:

        Manish,

        how safe liquid funds are ? can we say that they are 100% safe. When Liquid funds are category of debt funds then why it has more tax rate as 28.32% as opposed to 14.16% that any debit fund has?

        awaiting for your response

        1. Amol

          No liquid funds are not 100% safe, they are debt funds and they still carry the interest rate and default risk, however you can take them “as-good-as” safe . depends if you consider 1-2% risk as RISKY or not .

          Manish

  22. Trupti says:

    Hello Manish,

    I am little confuse over few things about taxes on MF.

    As i know(please correct me, if I am wrong)
    * Debt MF
    STCG : Will be added to your income slab
    LTCG: 10 per cent without indexation OR 20 per cent with indexation, whichever is lower

    I have two questions,
    – When we say that STCG will be added to income slab does it mean AMC do not deduct the taxes at source and I have to take care of it while filing the tax return for that fiscal year?
    Second question
    – If I buy debt oriented funds with a growth option in that case does DDT come into picture since I bought it with Growth option and NOT dividend.

    please guide on this

    Trupti…

    1. Trupti

      – Yes, AMC does not deduct anything at source , all the profit you get in your hand , its your obligation to pay tax on it and file the returns .

      – DDT is applicable only on Divided option of Debt funds , For growth option as there is no divided distributed to public , no DDT is applied . Also DDT is not applicable to Equity funds (even for dividend option).

      Manish

  23. Harpreet says:

    Manish,

    I have around 4.5 Lakh of surplus cash that I have saved in my “Marriage Fund” savings account. I want to move this whole amount to Liquid Funds (as I might have my marriage in another 4-5 months). I was able to go through the Debt:Liquid funds category on ValueResearch. Thought their allocation to “Debt” and “Other” instruments looks ok (NO equities), I am going ahead with “Fortis Money Plus Reg-G” Liquid fund plan. Just wanted to run by you to see if you can comment of this Liquid Fund and/or my plan of choosing Liquid Funds for this surplus money? I read in your article somewhere that “money that is lying ideally for more than a month, should be in Liquid Funds”. You are doing a fine job as because of your efforts I have gained some knowledge and have startede taking steps towards my PF.

  24. Amol says:

    Manish,

    –Will there be DDT in case of Debt funds with Growth option and which are hold/invested for long term (say more than 1 year)?
    — What is the tax structure for Equity MF which are sold below 1 year(as more than 1 year is tax free). How much tax is deducted at source ?

    1. Amol

      – No DDT in growth option , its only with dividend option of Debt Funds .

      – 15% tax on short term capital gains (less than one year) of equity funds (65%+ equity) . You have to pay taxes , there is no tax deducted at source

      Manish

  25. Pingback: A comprehensive Guide to Floating Rate Mutual Funds in India
  26. sandeep says:

    Hi, i need a small clarification on tax part on dividend reinvestment in liquid/debt funds. let me explain my doubt with an example

    CASE 1
    my investment is 1,00,000 (daily reinvetment option)
    assume after a month – 1,05,000 (menas 5000 is reinveted)

    CASE 2
    my investment is 1,00,000 (payout option)
    ater a month my current value is 1,00,000 (5,000 payout)
    now i want to reddem my amount in both cases. I know, in CASE 2, dividend payout is taxfree after DDT in hands of investors. But how about dividend reinvestment in CASE 1. Do i need to pay STCG

    Could you pls let me know

    1. Sandeep

      DDT will not be there if its an equity fund, DDT is applicable only to debt funds .

      So in case of Dividend reinvestment all your 5000 will be invested back in the same fund . nothing will be cut 🙂 . No STCG .

      Manish

  27. sandeep says:

    Hi, i need a small clarification on tax part on dividend reinvestment in liquid/debt funds. let me explain my doubt with an example
    CASE 1
    my investment is 1,00,000 (daily reinvetment)
    assume after a month – 1,05,000 (menas 5000 is reinveted)
    CASE 2
    My investment is 1,00,000 (5,000)
    after a month my my current value is 1,00,000 as 5000 is payout

    now i want to reddem my amount in both cases. I know, in CASE 2, dividend payout is taxfree after DDT in hands of investors. But how about dividend reinvestment in CASE 1. Do i need to pay STCG

    Could you pls let me know

  28. sandeep says:

    Hi, i need a small clarification on tax part on dividend reinvestment in liquid/debt funds. let me explain my doubt with an example
    CASE 1 CASE 2
    my investment is 1,00,000 (daily reinvetment) 1,00,000 (payout)
    assume after a month – 1,05,000 (menas 5000 1,00,000(5,000 payout)
    is reinveted)

    now i want to reddem my amount in both cases. I know, in CASE 2, dividend payout is taxfree after DDT in hands of investors. But how about dividend reinvestment in CASE 1. Do i need to pay STCG

    Could you pls let me know

    1. Sandeep

      DDT will not be there if its an equity fund, DDT is applicable only to debt funds .

      So in case of Dividend reinvestment all your 5000 will be invested back in the same fund . nothing will be cut 🙂 . No STCG .

      Manish

  29. Balbir says:

    Hi Manish,

    I looked at http://www.valueresearchonline.com/toprated.asp
    and I was looking for Liquid plus product so I checked Debt: Liquid Plus Inst

    And in all initial investment looks like 1 crore.. 🙁
    Also what is ‘pricing method’? what does ‘forward’ signify here?

    Thank you,
    Balbir

    1. manish says:

      Balbir

      go to the “Fund Details” and you will see the minimum investment required .. generaly its 5000 . No idea whats “forward”

      Manish

    2. Rajesh says:

      Just check “Debt: Liquid Plus”. It is for retail investors. “Debt: Liquid Plus Inst” category is meant for the institutional investors and the list provides the information about the MFs.

      1. Rajesh

        Thanks for the information 🙂

        manish

  30. Manish Chauhan says:

    @Vikrant

    * What is the minimum lock-in period

    No lock in period in most of them , they are not tax saving funds , hence you can take the money out anytime you want .. But make sure to check the fund rules . some fund might put some small locking period .

    * mimimum amount

    Depends on the Fund , but mostly you can start with 5-10k .

    * Which are best liquid funds available?

    You need to look at http://www.valueresearchonline.com/toprated.asp

    * How much time does it take to get invested amount back into bank account?

    Not sure .. depends on what kind of debt fund are you chooseing , but it can range from 3 days to 8 days .

    * How is it better from recurring deposit in the bank?

    Better taxation , Might be more returns (at cost of risk)

    Manish

  31. Anonymous says:

    Dear Manish
    I appreciate ur efforts and quick response to our queries.
    I would like to know more about liquid funds. What is the minimum lock-in period, mimimum amount,etc. Which are best liquid funds available? How much time does it take to get invested amount back into bank account?
    How is it better from recurring deposit in the bank?

    Regards
    Vikrant

  32. sumi says:

    Well I am now considering putting some amount in a liquid fund do you have any suggestions about the various options available?

  33. BizBlogged1 says:

    A stock fund or equity fund is a fund that invests in Equities more commonly known as stocks.

    Finance blog, finance,economics,Corporate finance,Personal finance,Investing,Marketing

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