Liquid Mutual Funds

Finding investment opportunities that offer liquidity must be a priority. Liquidity is the quality of purchasing assets or paying debts quickly without significant losses. You don’t have to wait long to recover your principal when selling an investment. Liquid funds are mutual funds that invest in fixed income and money-market instruments with a credit rating of AA or higher.

Liquid funds are ideal for investors with excess cash looking to invest it in short-term assets that provide a better return than a traditional savings account. They function similarly to other liquid debt funds. The main distinction between this and other debt funds is that these deposits are only for a brief period.

The investments may take the form of bonds, government securities, treasury bills, debentures, etc. They are referred to as debt instruments since they function as a form of borrowing for governments, banks, and businesses. When the market values of these securities fluctuate, the liquid fund's net asset value (NAV) adjusts as well.

What are Liquid Mutual Funds?

Liquid mutual funds are debt funds that lend short-term business loans for up to 91 days. Due to their exceptionally short loan tenure, they are the safest funds among all mutual fund types. There is no lock-in period with liquid money. On business days, redemption requests for liquid money are fulfilled within 24 hours.

Overall, assessments of liquid funds are moderate. They are the least dangerous of all debt fund classes, as they typically invest in premium fixed-income securities that expire quickly. Thus, these funds are appropriate for risk-averse investors. Liquid funds' returns are market-linked so they might provide negative returns. However, this is seldom the case because the best liquid funds invest in low-risk, short-term fixed-income assets.

Liquid funds provide much better returns than traditional savings accounts. With excess funds, it is prudent to put the funds in the best liquid funds or top 5 liquid funds to generate higher returns. Risk-averse investors may also consider investing in top liquid funds because the fund primarily invests in high-quality assets.

How do Liquid Mutual Funds Work?

Liquid funds operate on the same concepts as debt funds. The investor's goal in liquid mutual funds is to preserve capital and liquidity. Thus, the fund manager buys high-quality debt instruments and ensures that the scheme's portfolio's average maturity is no more than 91 days. This brief maturity term ensures that returns from liquid funds are less subject to changes in interest rates.

The best liquid funds match the maturity of their portfolios' maturity to their holdings' maturity consistently.

Similarly, according to the recent SEBI standards, liquid funds can only invest in listed commercial papers. These plans may have a total exposure restriction of 25% in each sector. In addition, liquid funds must keep at least 20% of their assets in liquid assets such as cash, money market securities, cash equivalents, etc. These liquid fund schemes strive to provide investors with a high level of liquidity and are regarded as one of the safest mutual fund categories.

One reason is that these schemes have grown in popularity among high-net-worth individuals and high-net-worth investors with short-term excess funds. It is highly advisable to invest in the best liquid funds or the top 5 liquid funds.

Who Should Invest in Liquid Mutual Funds?

Liquid funds are apt for investors who do not want to take any risk with their savings and park it in a safer option to get better returns than traditional bank accounts like savings and fixed deposits.

  • The conservative investor can invest in liquid funds as a parking option for their investment due for redemption within the next 3 to 6 months or even less than that.
  • For people who have excess cash or have lump-sum amounts that they would like to invest in for a short period, liquid funds are ideal.
  • Liquid funds also serve as an excellent alternative to the savings account, where one can earn higher liquid fund returns at relatively lower risk than other debt instruments.
  • These funds are ideal for investors who need cash but don't want to be exposed to market risks.
  • Liquid funds are also a good choice if you want to try out investing and grow your portfolio before moving on to more significant investments.

As per SEBI regulations, the minimum holding period for liquid funds is 91 days. These mutual fund schemes aim to generate returns by investing in highly liquid fixed income instruments with low risk while maintaining capital stability.

You can redeem your investment anytime without any exit load. Liquid funds returns are ideal for investors with a surplus amount that they do not want to invest in riskier assets.

Features of Liquid Mutual Funds

Good Returns – Liquid funds offer better returns than a traditional savings account or fixed deposits. The returns vary depending on various factors such as portfolio management skills, expense ratio, etc.

Easy to Invest – You can only invest in a liquid fund as low as Rs 1000.

High Liquidity – You can redeem your investment within 24 hours, which is excellent for emergencies.

A Variety of Options – Several categories to choose from based on your risk-taking ability.

Better Taxation – The tax structure for liquid mutual funds is similar to saving accounts, i.e., long-term capital gains taxation occurs at 20%

Low risk– Liquid funds returns carry low risk since the investments are made in high-rated short-term instruments. 

No lock-in period– There is no lock-in period for liquid funds, making it a preferred option for investors looking for an investment avenue that provides instant liquidity to meet their financial needs.

Factors to consider before investing in Liquid Funds

Here is a list of factors you can consider before investing in Liquid funds.

Investment goals

It is important to note that liquid funds don’t focus on wealth creation but on protecting the capital while generating modest returns. One of the biggest considerations is ensuring your financial goals match the objective of the mutual fund scheme you are interested in.

Risk appetite

As the underlying assets for these funds have a maturity period of up to 91 days, there is little volatility. This makes these funds low-risk investments. However, it does not mean there is no risk at all. Like other debt funds, liquid funds are subject to interest rates and credit risks. Investors must analyze their risk profile carefully before putting money into liquid schemes.

Expense ratio

One of the best ways to find the right liquid fund is by comparing the expense ratio of various schemes. As these funds have similar returns, a scheme with a higher expense ratio will reduce the gains significantly, and one with a lower expense ratio will be profitable for the investor.

Fund’s past performance

The returns generated by liquid funds cannot be predicted because they can vary depending on the interest rates in the market. Therefore, investors must check and compare historical returns of various schemes and choose the one that delivers consistently strong performance. Though past performance does not guarantee future results, it helps assess how well the fund responds to different economic conditions.

Investment plan

If you opt for a direct plan, you can directly invest with an AMC. However, you need a third party like a broker to facilitate the transaction for regular plans. Fund houses, therefore, charge additional brokerage or commission, making regular plans more expensive with a higher expense ratio and lower NAV.

Fund manager

The success of liquid mutual funds depends on the ability and experience of the fund managers. These professionals utilize various techniques to assess risks for different investments and make decisions. A skilled and experienced fund manager is more likely to meet the scheme’s objective.

Taxability of Liquid Funds

The taxability of the best liquid funds depends on the holding period. The holding period is the duration for which you have kept your money invested in a liquid fund.

According to the income tax slab, liquid funds are subject to capital gains tax if you sell the units within three years of buying them.

If you sell after three years, long-term capital gains (LTCG) tax of 20% per cent with indexation benefits will apply. Indexation means adjusting the purchase price of an asset for inflation using the cost inflation index (CII).

If you have redeemed your investment for three years, the total returns will be added to your income and taxed according to the income tax slab rate. After three years, 20% of the interest earned will be taxed at 20% if you have redeemed investments.

Risks involved with Liquid Funds

Liquid funds returns also carry a risk of capital erosion and the possibility of negative returns. This happens because the NAV of liquid funds is net asset values (NAV) that fluctuate daily. However, since these funds invest in short-term money-market instruments, the chances of their NAVs going down are minimal.

The stability of the NAV is directly dependent on the interest rates in the economy. When interest rates rise, the yield on liquid fund investments reduces, which results in a drop in the NAV. When interest rates fall, the yield on liquid fund investments increases the NAV.

When interest rates fall, debt funds have to mark down their portfolio securities to market prices. The extent of this markdown depends on how long each security has until maturity. This results in a negative impact on returns for investors holding these funds and those redeeming their money from these funds.

The primary risk associated with the best liquid funds is credit risk. This means that if an issuer defaults on its debt obligations, it can negatively impact your return from the fund or even lead to capital erosion if you have invested a substantial portion of your corpus into that particular fund or scheme.

Advantages of Liquid Funds

  • A liquid fund is an investment that gives the convenience of a savings account and access to a checking account, but with a higher interest rate than if you kept your money in either.
  • Liquid funds diversify your investment across different companies to don’t have all your eggs in one basket.
  • Since the investments have low maturity periods, the issuer has less risk of default. The NAVs of these funds are not affected by interest rate changes since they only invest in short-term instruments.
  • Since investments are made in debt instruments with low maturity periods, you can redeem your investment quickly at any time.

Liquid funds are tax-efficient as short-term capital gains on redemption within three years are taxed at the investor’s marginal tax rate. After three years, long-term capital returns are taxed at 20% with indexation benefit.

Top Liquid Funds

Let us take a look at some of the best-performing liquid funds worth checking out.

Quant Liquid Direct Plan-Growth

This mutual fund scheme from Quant Mutual Fund was launched in 2013 and currently has INR 727 crore worth of assets under management. This fund aims to deliver consistent returns and has a high capability of controlling losses in an adverse situations.

The expense ratio of this debt fund is 0.29% which is somewhat higher than most other liquid funds. The top holdings in the fund are Reliance Retail Ventures, HDFC Bank, Punjab National Bank, and Axis Bank.

  • AUM – INR 727 crores
  • Investment Amount – INR 5000
  • SIP Amount – INR 1000
  • 1-Year Returns – 5.27%

Aditya Birla Sun Life Liquid Fund

This scheme aims to provide reasonable returns with a high level of liquidity and safety through thoughtful investments in high-quality money markets and debt instruments.

The fund has existed for over 9 years and has an expense ratio of 0.21% which is much similar to what other liquid funds charge.

Since its inception, this scheme has delivered annual returns at an average rate of 6.87%. The top holdings in this fund are Tata Steel, RBI, Reliance Ventures, and Punjab & Sind Bank.

  • AUM – INR 32,891 crores
  • Investment Amount – INR 500
  • SIP Amount – NA
  • 1-Year Returns – 3.9%

Mahindra Manulife Liquid Fund

This liquid fund aims to deliver impressive returns with higher liquidity and lower risk through a portfolio made up of high-quality securities.

It belongs to the debt category of Mahindra Manulife mutual funds and has managed to give 5.45% annualized returns in the past five years.

  • AUM – INR 923 crores
  • Investment Amount – INR 1000
  • SIP Amount – INR 500
  • 1-Year Returns – 4.0%

IDBI Liquid Fund

This moderate-risk debt liquid fund aims to provide investors with high liquidity and regular income generation.

The fund seeks to achieve the objective through a portfolio of money market and debt securities with a maturity period of up to 91 days. The scheme has delivered a 3-year annualized return of 4.25% and a lower expense ratio of 0.13%.

  • AUM – INR 602 crores
  • Investment Amount – INR 5000
  • SIP Amount – INR 1000
  • 1-Year Returns – 3.9%

Axis Liquid Direct Fund

This scheme from Axis Mutual Fund has been around for over nine years and is a medium-sized fund in the category. This liquid fund has an expense ratio of 0.13%, which is close to others in the market.

It aims to deliver reasonable returns with significant liquidity and low risk through a portfolio comprising debt securities and money market instruments. The top holdings in this fund are Reliance Retail Ventures, RBI, Hindustan Petroleum, and Bharat Petroleum.

  • AUM – INR 20917 crores
  • Investment Amount – INR 1000
  • SIP Amount – INR 500
  • 1-Year Returns – 4.6%

Sundaram Liquid Direct Growth

This liquid fund is one of the best-performing debt funds of the time and was launched 18 years ago. Its objective is to provide the highest income level to investors from short-term investments while preserving capital and maintaining liquidity.

It does so by investing in a portfolio of high-quality debt instruments. This scheme has delivered 4.11% annualized returns in the last three years.

  • AUM – INR 2539 crores
  • Investment Amount – INR 5000
  • SIP Amount – INR 1000
  • 1-Year Returns – 3.9%

Navi Liquid Fund Super Institutional Plan

Launched back in 2013, this liquid scheme from Navi Mutual Fund is a small fund in its category. The fund’s expense ratio stands at 0.15%, which is quite close to the industry standard. Since its inception, the scheme has delivered average annualized returns of 6.83%.

The fund can deliver consistent returns in line with most other schemes in the category. Top holdings in the fund are Time Technoplast, Godrej Industries, RBI, IFMR Capital Finance, etc.

  • AUM – INR 83 crores
  • Investment Amount – INR 1000
  • SIP Amount – INR 500
  • 1-Year Returns – 4.51%

HDFC Liquid Direct Plan

A well-performing liquid fund from HDFC Mutual Fund, this scheme has existed for over nine years and is a medium-sized fund in the category. The expense ratio of 0.2% is close to other liquid funds. Since its inception, the scheme has delivered an average annualized return of 6.76%. It aims to generate income through a money market portfolio and debt instruments.

  • AUM – INR 49149 crores
  • Investment Amount – INR 5000
  • SIP Amount – INR 1000
  • 1-Year Returns – 3.8%

Franklin India Liquid Fund

This liquid fund scheme from Franklin Templeton Mutual Fund has been around for more than nine years. Since its launch, the scheme has delivered an average annual return of 6.9%. The fund aims to provide investors with a regular income stream with high liquidity. Top holdings in the fund include RBI, LIC Housing Finance, Reliance Retail Ventures, and Indian Oil Corporation.

  • AUM – INR 1336 crores
  • Investment Amount – INR 10000
  • SIP Amount – INR 500
  • 1-Year Returns – 3.1%

JM Liquid Fund

This liquid fund aims to create income for investors through dividends and capital gains by investing in various securities that mature within 91 days. It is a debt fund that delivered an average annualized return of 5.2% over the last five years. Top holdings in the fund include HDFC Bank, Tata Steel, Canara Bank, etc.

  • AUM – INR 1808 crores
  • Investment Amount – INR 5000
  • SIP Amount – INR 1000
  • 1-Year Returns – 3.8%

Frequently Asked Questions

Liquid funds are most suitable for investors with a short-time horizon, who may need liquidity shortly, or have come into some liquidity, which they don’t plan on using for the next few weeks.
Such funds offer an opportunity to keep excess funds or reserves safe while putting them to work to earn moderate rates of returns.

Install the ET app or visit their website first. Visit the mutual fund’s section. Next, choose and select the Liquid fund you want to invest in. Click on the ‘invest’ option and select the amount you want to invest. After that, provide your KYC details and complete the process.

Liquid funds, as a rule of thumb, offer lower market risks when compared to other classes of mutual funds; however, they mostly remain on the same levels when it comes to risks and rewards as against fixed deposits.
While the marginally higher rate of returns, lower minimum investment values, and premature withdrawal penalties have made this an attractive alternative, investors in such funds assume higher risks when compared to fixed deposits at banks.
However, with most liquid funds investing in high-quality credit assets, diverse allocations, and short maturity dates, the risks are still relatively muted for average retail investors.

The most significant appeal of liquid funds is the instant withdrawal facility, allowing investors to take out their funds within just a day after putting them in while earning the interest, however small, for the day’s investment.

Funds that offer this facility allow investors to withdraw up to ₹50,000 almost instantly, with withdrawals processed within 24 hours of placing the request, and beyond this amount, up to 90% of the total investment can be withdrawn at any given time.

It had only happened during exceptional circumstances, such as during the 2008 financial crisis, when the Federal Reserve announced that interest rates would go up, resulting in global bond markets going awry overnight.

Given the extensive regulations and standards to which these funds are held, and the superior quality of credit instruments that they invest in, the chances of suffering a loss on your initial capital remain relatively rare.

Liquid mutual funds deliver higher returns as compared to savings bank accounts. So, if you have some extra funds, you can consider putting them in liquid funds to earn better returns. This type of scheme is also ideal for contingency funds. They primarily focus on capital preservation while generating consistent returns.

Investors can withdraw their units in liquid funds whenever they want. Well-performing liquid funds are therefore perfect for investors willing to save over a short period. Moreover, as the funds primarily invest in high-quality instruments, those with a low-risk appetite can also consider liquid funds for their financial goals.

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