Liquid funds are often overlooked in personal finance, yet they offer a flexible, safe, and efficient way to manage money for short-term needs, emergencies, or parking lump sums before equity investments. Here’s a detailed guide on what liquid funds are, why they’re useful, how they work, when they’re the right choice, and how to pick the best one for your financial goals.
What Are Liquid Funds?
- Definition: Liquid funds are a type of debt mutual fund that invests in short-term debt instruments, typically maturing within 91 days.
- Instruments Used:
- Treasury bills (issued by the government)
- Commercial paper (issued by corporates)
- Certificates of deposit (issued by banks)
- Call money (overnight lending between banks)
- Purpose: These funds lend money for short durations to high-quality borrowers, aiming to provide steady returns with low risk.
Why Are They Called ‘Liquid’?
- Liquidity refers to how quickly you can access your money.
- Liquid funds allow redemption typically within one working day; some offer instant withdrawal (up to a daily limit, e.g., ₹50,000).
- They are nearly as accessible as savings accounts but may provide better returns.
How Much Return Do Liquid Funds Offer?
- Returns fluctuate with market interest rates but generally range from 6–7% annually (pre-tax).
- Recent top performers include:
- Canara Robeco Liquid Fund: ~7.3% return in one year
- Axis Liquid Fund and similar funds also offer competitive returns
- Returns outpace typical savings accounts (usually 2.5–4%).
When Should You Use a Liquid Fund?
Ideal scenarios include:
- Parking money temporarily after selling stocks or funds before your next investment
- Building or maintaining an emergency fund
- Deploying a lump sum into equity systematically (using STP – Systematic Transfer Plan)
- Saving for short-term goals (3–6 months away) like tuition, travel, or renovations
- Holding funds set aside for upcoming SIPs (Systematic Investment Plans)
- Any sum you might need soon but want to earn more than a savings account offers
Are Liquid Funds Safe?
- Very low risk, but not zero risk:
- Credit Risk: The borrower doesn’t repay (rare in liquid funds as most holdings are AAA/A1+ rated)
- Interest Rate Risk: Minimal, since investments mature quickly (under 91 days)
- Default Risk: Very low, but can arise if fund managers take excessive risk for higher returns
- Advice: Prefer funds from reputable AMCs with a conservative, high-quality credit portfolio
How Are Liquid Funds Taxed?
- If held less than 3 years: Gains are short-term and taxed as per your income slab (like FD interest)
- No TDS (Tax Deducted at Source) unlike FDs, so you control when and how to declare the gains
- Returns are still often more attractive than savings accounts after tax if held for a few months or longer
How to Pick the Right Liquid Fund
Key Criteria:
- Recent Performance: Check 1-year returns as liquid funds aren’t for the long term.
- Expense Ratio: Lower is better. A high expense ratio can erode your net return.
- AUM (Assets Under Management): Aim for funds with a decent size—not too small (indicates trust and track record).
- Portfolio Composition & Credit Quality: Prefer funds with the majority holdings in high-rating instruments (AAA or A1+).
Example Comparison Table:
| Fund Name | 1-Year Return | Expense Ratio | AUM Size | Credit Quality |
|---|---|---|---|---|
| Canara Robeco Liquid Fund | 7.3% | 0.08% | Decent | AAA/A1+, Sovereign |
| Axis Liquid Fund | ~7.3% | 0.12% | Moderate | AAA/A1+ |
| Aditya Liquid Fund | ~7.1% | 0.21% | Good | AAA/A1+ |
| PGIM Liquid Fund | ~7.0% | Low | Decent | High |
- Recommendation: Combine all three criteria for the best result—returns, expense ratio, and AUM.
- Final Tip: Check fund’s portfolio for predominantly AAA/A1+ rated instruments or government securities to ensure safety.
Conclusion
Liquid funds provide an optimal balance between safety, accessibility, and performance for short-term or parked funds. They beat savings accounts for returns, are more flexible than FDs, and are ideal for managing cash reserves smartly. For best results, prioritize funds with reputable management, a proven track record, low expenses, and top-notch credit quality.