Liquidity in mutual fund: Converting investment into cash

If you’re investing in mutual funds, one of the most common questions you might have is — how quickly can I get my money back when I need it? That’s exactly what liquidity in mutual funds is all about. Liquidity tells you how easily and quickly your investment can be converted into cash without losing much of its value. Understanding it helps you plan for emergencies, balance risk and make smart exit or reinvestment decisions. Let’s explore what liquidity means, how it impacts your mutual fund investments and what factors you should consider before choosing a scheme. 

What is Liquidity in Mutual Funds? 

In simple terms, liquidity refers to how easily you can convert your investment into cash. In mutual funds, it shows how quickly you can sell your units and get your money without a significant loss in value. 

A highly liquid asset allows quick redemption that is ideal for emergencies. For example, money market instruments, gold and large-cap stocks are considered highly liquid. 

On the other hand, investments like tax-saving fixed deposits or retirement funds have a low liquidity since you can’t withdraw them before a lock-in period end. 

Apart from market liquidity, there’s also accounting liquidity, which shows how quickly an investor or company can meet obligations by liquidating assets. This concept is also useful while evaluating mutual fund portfolios. 

How Does Liquidity Affect Investment Decisions? 

Liquidity plays a huge role in shaping how you build and manage your mutual fund portfolio. Here’s how: 

• Emergency Readiness: High liquidity ensures quick access to funds when unexpected expenses arise. 

• Portfolio Flexibility: Lets you switch between schemes or book profits without much hassle. 

• Market Timing: Helps you take advantage of sudden market opportunities by entering or exiting easily. 

• Reduced Risk: Low liquidity can increase risk, especially if you can’t redeem your funds during downturns. 

• Expense Awareness: Selling mutual funds too early may attract exit loads, affecting your final returns. 

Five Things to Know About Liquidity in Mutual Funds 

Here are key points every investor should keep in mind: 

• Liquidity differs by fund type: Open-ended funds are more liquid than close-ended ones. 

• Exit load matters: Some mutual funds charge a small fee for early redemption. 

• NAV fluctuations: Selling during market lows can reduce your overall gains. 

• Fund manager’s strategy impacts liquidity: Portfolios with large-cap or frequently traded securities are easier to redeem. 

• Investor demand drives liquidity: Funds with higher investor activity tend to be more liquid. 

Role of Liquidity in Investments 

Liquidity is more than just accessibility — it influences your entire investment experience. Here’s how it plays a role: 

• Helps balance risk and return by allowing timely exits during volatile markets 

• Supports short-term financial goals since funds with high liquidity can be redeemed quickly 

• Increases investor confidence because liquid assets are easier to track and manage 

• Improves overall portfolio health by maintaining the right mix of liquid and long-term assets 

• Acts as a financial safety net when sudden financial needs arise 

Why Does Liquidity Matter in Mutual Funds? 

Liquidity in mutual funds affects both your risk exposure and potential returns. Here’s why it’s crucial: 

• Risk Assessment: Funds with low liquidity often carry higher risk since you may struggle to sell units quickly. 

• Total Returns: Selling during a market downswing or paying exit loads can affect returns. 

• Quick Redemption: Highly liquid funds allow faster redemption with minimal losses. 

• Credibility of the Funds: Liquid funds attract more investors, making them more stable and reliable. 

• Investment Horizon: Short-term funds offer high liquidity but lower returns, while long-term funds do the opposite. 

Market Liquidity 

Market liquidity refers to the ease of buying and selling securities in the market. For instance, mutual funds invested in large-cap stocks tend to have higher market liquidity because these securities are traded frequently. In contrast, funds with investments in niche or small-cap securities may have lower market liquidity. 

Factors to Consider 

If you’re looking for liquidity in mutual funds, keep these points in mind: 

• Risk Appetite: Choose liquid funds if you prefer low-risk investments. 

• Exit Load: Pick funds with low or no exit load for easier withdrawals. 

• Liquidity Risk: This arises when investors can’t redeem their units quickly, especially in funds holding less commonly traded securities. 

• Commonly Liquid Funds: Money market securities, Large-cap mutual funds and Government bonds 

A highly liquid fund lets you buy and sell units without affecting the market price. Fund managers maintain this liquidity by managing cash inflows, dividend payouts and investing in liquid instruments. 

If your mutual fund has low liquidity, you don’t need to sell it. You can simply apply for Fibe’s Loan Against Mutual Funds. This allows you to pledge your mutual fund units as collateral and get up to 80% of their value (up to ₹10 lakhs) without liquidating your investment. 

Download the Fibe App and meet your financial needs while keeping your investments intact. 

FAQs on Liquidity in Mutual Funds 

1. How does the lock-in period in mutual funds affect liquidity? 

Lock-in periods provide investment stability and higher returns but reduce liquidity since you can’t withdraw funds before the period ends. 

2. How can I check the liquidity of a specific mutual fund? 

Check its cash ratio, review fund documents and analyse its average daily trading volume to see how often investors buy and sell units.