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Liquid Funds : Basics, Things to consider and More

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Liquid funds invest in short-term fixed-interest generating money market instruments. These can be treasury bills, commercial paper, etc which mature within a period of 91 days.

This article covers the following:

  1. How do Liquid Funds work?
  2. Types of Money Market Instruments
  3. Who should invest in Liquid Funds?
  4. Things to consider as an investor
  5. How to Invest in Liquid Funds?
  6. Top 5 Liquid Funds in India


1. How do Liquid Funds work?

Liquid funds aim at providing a high degree of liquidity and safety of capital to the investor. For this reason, the fund manager invests in high-credit quality debt instruments. The allocated proportions are as per the fund’s investment mandate. He/she ensures that average maturity of the portfolio is up to 3 months.

This reduces the sensitivity of fund returns to interest rate changes. The fund value does not experience severe fluctuations. In addition to this, the maturity of the underlying securities is matched to the portfolio maturity. It helps to deliver higher returns.

Liquid funds are an efficient way to park surplus funds. These are low-risk havens which provide higher returns than a savings bank account. Liquid funds try to emulate the liquidity aspect of a savings bank account. These funds don’t have exit loads. It gives you the freedom to withdraw funds as per your convenience.

2. Types of Money Market Instruments

As an investor, you should know the various money market instruments:

a. Certificate of Deposit (CD) 

These are time deposits like fixed deposits that are offered by scheduled commercial banks. The only difference between FD and CD is that you cannot withdraw CD before the expiry of the term.

b. Commercial Paper (CPs)

These are issued by companies and other financial institutions which have a high credit rating. Also known as promissory notes, commercial papers are unsecured instruments which are issued at the discounted rate and redeemed at face value. The difference is the return earned by the investor.

c. Treasury Bills (T-bills)

T-bills are issued by the Government of India to raise money for a short-term of up to 365 days. These are the safest instruments as these are backed by the guarantee of government. The rate of return, also known as risk-free rate, is low on T-bills as compared to all other instruments.

3. Who should invest in Liquid Funds?

Liquid funds are meant for those who have substantial idle cash and are looking for short-term investment havens. Instead of keeping it in a savings bank account, you may invest that performance incentive which you received recently or some windfall gains in a liquid fund.

These can be used as a medium to invest in equity funds. You may initially invest the money in a liquid fund and then do a systematic transfer to an equity fund of your choice over a specified time period. In this way, you would save yourself from placing large bets all of a sudden into equity funds.

Who should invest in Liquid Funds


4. Things to consider as an investor

a. Risk

Basically,  the risk in mutual funds relates to fluctuations in its Net Asset Value (NAV). For liquid funds, the NAV doesn’t fluctuate too frequently because the underlying assets mature within 60-91 days. This somehow prevents the fund NAV from getting impacted too much by the underlying asset price fluctuations. However, the fund value might drop suddenly on account of a sudden downgrade of the credit rating of the underlying security. To put it simply, liquid funds are not completely risk-free.

b. Returns

Historically, liquid funds have been found to generate returns in the range of 7%-9%. It is way higher than the mere 4% returns obtained on savings bank account. Even though the returns on liquid funds are not guaranteed, in most of the cases they have delivered positive returns upon redemption.

c. Cost

Liquid funds charge a fee to manage your money called an expense ratio. SEBI has mandated the upper limit of expense ratio to be 1.05%. Considering the hold till maturity strategy of the fund manager, liquid funds maintain a lower expense ratio to provide relatively higher returns over a short period of time.

d. Investment Horizon

Liquid funds are exclusively meant to invest surplus cash over a very short period of time say up to 3 months. Such a short horizon helps to realise the full potential of the underlying securities. In case you have a longer investment horizon of up to 1 year, then you may consider investing in ultra-short term funds to get relatively higher returns.

e. Financial Goals

If you want to create an emergency fund, then liquid funds can prove to be very useful. In addition to receiving higher returns, these will help you to take out your money easily in case of emergencies.

f. Tax on Gains

When you invest in debt funds, you earn capital gains which are taxable. The rate of taxation is based on how long you stay invested in a debt fund called as the holding period. A capital gain made during a period of less than 3 years is known as a Short-term Capital Gain (STCG). A capital gain made over a period of 3 years or more is known as Long-term Capital Gains (LTCG).

STCG from debt funds are added to the investor’s income and taxed according to his income slab. LTCG from debt funds is taxed at the rate of 20% after indexation.

5. How to Invest in Liquid Funds?

Investing in Liquid Funds is made paperless and hassle-free at ClearTax.

Using the following steps, you can start your investment journey:

Step 1: Sign in at
Step 2: Enter your personal details regarding the amount of investment and period of investment
Step 3: Get your e-KYC done in less than 5 minutes
Step 4: Invest in your favourite debt fund from amongst the hand-picked mutual funds

6. Top 5 Liquid Funds in India

While selecting a fund, you need to analyse the fund from different angles. There are various quantitative and qualitative parameters which can be used to arrive at the best liquid funds as per your requirements. Additionally, you need to keep your financial goals, risk appetite and investment horizon in mind.

The following table represents the top 5 liquid funds in India based on the past 1 year returns. Investors may choose the funds based on a different investment horizon like 5 years or 10 years returns. You may include other criteria like financial ratios as well.

Fund Name
3 year5 year
Aditya Birla Sun Life Liquid Regular Plan Growth 7.28%7.89%
ICICI Prudential Liquid Fund Growth7.24%7.85%
Reliance Liquid Fund Growth
UTI Liquid Fund Cash Plan Regular Plan Growth6.6%7.18%
Axis Liquid Institutional Growth7.27%7.87%
Kotak Liquid Fund Growth


*The order of funds doesn’t suggest any recommendations. Investors may choose the funds as per their goals. Returns are subject to change.