Liquidity in Mutual Funds and the Impact of Withdrawal on Returns

Liquidity in Mutual Funds and the Impact of Withdrawal on Returns

Liquidity is essential for investors. They might need funds for education, medical emergency, or to invest in a different asset class. Mutual funds are popular because they offer investors instant liquidity. Investors can invest and withdraw their mutual fund investments within days, making a quick return. This article introduces you to mutual fund liquidity and how withdrawals impact returns.

What is liquidity in mutual funds?

Mutual fund liquidity protects investors at the time of an emergency. Investors can remove their investments in various mutual funds whenever they want to. In fact, liquidity is one of the vital factors investors to consider when investing in mutual funds. It helps investors in the following ways:

1. Helps build a reserve fund

First-time investors often wonder whether they must keep their investments on hold for a few months to save up for their reserve fund or invest their saved income. A balance is ideal since you must always have cash reserves worth at least three months of your salary for unforeseen situations. Thanks to the liquidity in mutual funds, you can invest your savings and remove them whenever you want to.

2. Allows you to invest in several assets 

Any asset can be a ‘liquid’ or ‘illiquid’ asset depending on the liquidity offered to investors. Real estate is an illiquid asset since it offers low liquidity. Assets such as stocks and mutual funds are examples of liquid assets. You must maintain a balance of liquid and illiquid assets in your investment portfolio to grow your wealth over time.

3. Simplifies the selling process

Liquidity or access to cash can help you sell your assets more conveniently. Investors generally find it easier to sell a liquid asset than an illiquid one. Moreover, selling a liquid asset can help during financial emergencies by helping access an extra amount apart from your savings.

4. Easy to switch between investments 

At times your investment may underperform causing undesirable results. However, if your investments are liquid, you can easily switch them to another profitable investment. If you have adequate liquidity in your investment, you may switch to a better option even by booking a loss, but with an illiquid investment, you may suffer losses for a longer duration and miss out on your financial objective. Moreover, financial goals may change over time, having liquidity in your investment can help you meet your changing goals by switching between various investment options. 

6. Increase liquidity with the right investment option

You can increase your reserve of liquid funds by investing in a mutual fund, offering convenient withdrawals such as SWP (Systematic Withdrawal Plan). An SWP (Systematic Withdrawal Plan) allows you to invest a lump sum amount in a mutual fund while letting you withdraw  from your mutual fund periodically and at a fixed frequency. Therefore, it offers high liquidity.

For example, if you invested a sum of ₹1,00,000 for a year and decided to withdraw ₹ 10,000 every month, your investment will reduce by that amount every month. Simultaneously, the amount left every month after withdrawal will remain invested. You can use a systematic withdrawal plan calculator online to invest in such a plan.

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