A frequently heard term when investing in mutual funds is liquidity. In case of investing, liquidity refers to the extent to which the investment in a fund can be redeemed or converted to cash. Liquidity is a particularly important attribute which mutual fund investments have. Certain types of funds are so liquid that if you send a redemption request before lunch on a working day, the money will reflect in your linked bank account the next morning. Then, there are funds which typically honour redemptions within five working days. This trait of mutual funds is very useful, at the same time it is something that often gets misused as investors tend to exit their investments just because they get to see a gain in their investments, which leads to exiting the investment for no planned reasons. Then, there are a few types of funds which have a defined lock-in period, like a three year lock-in from the date of investment in case of equity-linked savings scheme (ELSS), which are mutual funds in which investments qualify for tax deductions under Section 80C of the income tax act.
Impact: Investors should view liquidity as a tool to improve their investments than use it as an exit mechanism. For instance, one should redeem an investment if the fund performance dips instead of exiting because the fund performance is good and there have been gains in the investments one makes.
