What are Liquid Funds? Meaning & Details

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Short Answer

Liquid funds, a type of mutual funds which invest in different money market instruments. The withdrawals from these funds are processed within 24 hours and that's why these are regarded as liquid assets. The fund manager gets flexibility to meet immediate redemption requests.

Detailed Answer

You will get an answer to following questions:

  • What are liquid funds?
  • Where do liquid funds invest?
  • What are the top liquid funds in India?
  • Why and when you should invest in liquid funds?
  • Why liquid funds are better than saving accounts?
  • Liquid funds versus Fixed deposits
  • Tax implications of liquid funds
  • How to chose liquid funds?

What are liquid funds?

Liquid funds are class of mutual funds which invest in Money market instruments like treasury bills, commercial paper, certificate of deposits, and term deposits most of these assets have 3 months to 13 months of maturity period which in turn gives fund manager flexibility to meet immediate redemption requests.

Why are they called liquid funds?

Liquid name comes from the fact that withdrawals from these funds are processed within 24 hours hence its quite a liquid asset.

Why should you invest in Liquid Funds?

  • Liquid funds provide 24 hour withdrawal rates, hence is a good instrument to park your emergency funds ( which you can require at short notice)
  • Returns do not fluctuate much as they invest in short term debt instruments and interests rates do not change so much in short term , hence they are relatively risk free.
  • Come with zero entry and exit loads, hence not many overheads in investments
  • Flat tax outgo on liquid funds is is 28.325 % If you are in 30 % tax bracket, and hold on to liquid funds for more than a year, you will save on some tax out go as
  • They give higher return than savings account hence move your money from savings account immediately

What are the various option in Liquid funds?

Top liquid funds in India as per Crisil are as follow

  • India bulls liquid fund
  • L&T liquid funds
  • Sundaram money fund
  • Axis Liquid Fund
  • DSP black rock liquidity fund

For detailed analysis of top liquid funds in 2016 subscribe to our news letter

Why Liquid funds are better than savings account?

Liquid funds are better than savings account for following reasons

  • They provide superior returns over savings account, in general top performing liquid fund can gave you anything between 1-2 % higher return
  • At the same time it is as liquid as Saving account money, money can be credited to you in 24 hours, and does not carry too much risk.

*There is no exit load

For more details read my post on Liquid Funds versus Savings account

Tax implications of Liquid Funds

  • If you chose growth options and you do not withdraw within a year liquid funds are supposed to pay Dividend Distribution Tax (DDT), As per current income tax norms rate of DDT is 28.325 % ( Tax Rate 25 % + 10 % surcharge + 3 % Cess).
  • In case your tenure is less than a year then short term capital gains are taxed at your personal tax rate
  • So in general if your tax slab rate is 30 %+ , you should invest in dividend re-investment which will make it more tax effecient , if your are in lower bracket you can take out your dividend.
  • The other good thing is in general Mutual funds do not deduct tax at source, so you have more time.

Liquid Funds vs. Fixed Deposits

  • Liquid funds offer better liquidity then Fixed deposits, you can get your money in 24 hours and for some funds through ATM also.
  • There is no exit load for liquid funds but in case of an FD for premature withdrawal one has to pay a penalty
  • In last 2-3 years Liquid funds have outperformed FDs in terms of returns

With recent changes there are not much difference in how tax treatment of FDs and Liquid funds

  • Liquid Funds vs. Ultra Short term Debt Funds
  • Liquid funds invest in securities with maturity upto 91 days, Ultra short term debt funds invest in securities with maturity upto 1 year
  • Liquid funds come with no exit load, some of the ultra short term debt funds come with an exit load
  • Due to nature of underlying securities volatility and risk is lower for liquid funds, as compared to short term debt funds

How to chose a liquid funds?

Key factors to look at while chosing a liquid fund are as follow

  • Size of the fund , in general it is a positive sign for me since most of the investments in a liquid funds are from institutional investors , it is always
  • Credit rating of the scheme , you can refer to Crisil rating
  • Look at the portfolio of the investments made by the fund
  • Look at expense ratio, all things being same ,I would prefer funds with lower expense ratio

When should you invest in liquid funds?

Liquid funds investments are best to park money which you require almost immediately, so my first suggestion will be that move all your cash holdings and savings account holding to liquid funds, you can also move part of FDs also to liquid funds, chose dividend re-investment option if you come under tax 30 % tax bracket.

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