Liquidity – how easily available is your money – is an important factor that is often overlooked in the rush to maximise returns. Typically, the more liquid you want to keep your money, the less it’s going to earn you. The most liquid option is to tuck it under your proverbial mattress, contributing to a most uncomfortable bed and security headaches. But it’s right there whenever you need it.

The humble bank account is an improvement. The money is there, almost as close as your mattress, but there are no security headaches, a good night’s sleep and the ability to withdraw it in hard cash, spend it via cold plastic or transfer to others in foldable cheques.

But returns on bank accounts are abysmally low (and sometimes zero), so it’s not the most optimal way to store that cash for when you might need it. Certainly, they are essential for your day to day needs, but if you need to keep an emergency pool of cash handy or if you need to temporarily park some money while it waits to be spent or invested, there’s a better way.

Mutual funds are very good partners to have when it comes to investing your money and for liquidity there’s a little-used option called the (duh) liquid scheme. Different funds call it by different names: cash funds, money management funds, treasury funds and so on, but they all share the same fundamental characteristics: liquidity, safety and tax free returns – all of which are about as fundamental to your peace of mind as it gets.

A liquid scheme invests your money in money market instruments, which is a fancy way of saying that it parks your money in much the same kind of investments that your bank does when it accepts your money into your savings bank account. These investments are certificates of deposits offered by (other) banks, very short term government and central bank paper and similar safe investment options that have very short maturity periods.

But that’s jargon.

What you need to concern yourself with are three questions: is my money safe? Can I get it when I want it? Does it give me a better return than keeping it in the bank?

The answer to all three questions is the same: a resounding “Yes”.

Your money is as safe as it were if you were to keep it in your bank account. That’s because the liquid scheme is investing in much the same paper as your bank would.

You can get your money out at literally a working day’s notice. Pop in a redemption request on Monday and the money is in your bank account on Tuesday. Do note the “working” day fine print, though. If Tuesday’s a bank holiday, then your Monday redemption will find its way to your bank account on Wednesday.

Your liquid scheme earns you a return or interest that matches what the market is currently offering. That is typically a bit more than the going savings bank rate of interest. The interesting bit is that it’s entirely tax free because of the way mutual funds pay interest. They don’t. Instead, they pay dividends and dividends are tax free in India. So, your return is tax free.

There’s yet another interesting twist to the liquid schemes tale. If you opt for a daily dividend reinvestment option, the mutual fund pays you a dividend each day and each day it buys you an additional number of units in the liquid scheme equivalent to this dividend. This has the effect of bumping up your investment in the scheme (by the dividend amount) and increasing the number of units that you hold. But because the number of units are going up, the price per unit remains more or less the same.

This means that when you actually sell (redeem) the units, the price at which you sell is the same as the price at which you bought, so there are no capital gains to be taxed. Remember, you now own more units which means you will get more out of the sale than what you put in, but because you got those extra units via a tax free dividend, you have no gains to be taxed, so you can laugh all the way to the bank.

Liquid schemes are an excellent option to safely park your money either for a rainy emergency or while you wait for a better investment opportunity. They are also a great option if you have a lump sum of money that you want to put into an equity scheme but you want to do the sensible thing of investing into equity over a period of time rather than in one shot.

Instead of dumping the money into equity in one make-or-break shot and realising that your timing of the market was (inevitably) all wrong, park the money in a liquid scheme and opt to have it systematically transferred out each month (or week or day) into the equity scheme of your choice over the period of your choice (at least a year, in our opinion). While your systematic investing offers you the chance to average out your investment cost, your money continues to earn you a tax free return while it sits in the liquid scheme until it’s invested.

Liquid schemes deserve to be more widely used than they are.