Liquid funds are low-duration debt mutual funds that invest in money-market instruments maturing within 91 days. They’re designed for short-term parking of surplus cash with T+1 liquidity (often same-day via Instant Access Facility up to ₹50,000 or 90% of your balance) and lower volatility than other debt categories. Taxation on post–1 April 2023 investments is at your slab rate. (AMFI India) (PPFAS Mutual Fund, trustmf.com) (AMFI India)
What is a Liquid Fund?
Liquid funds are a SEBI-defined debt scheme category that invests only in debt and money-market securities with residual maturity of up to 91 days (e.g., T-Bills, Treasury/Repo, Certificates of Deposit, Commercial Paper). The short maturity profile keeps interest-rate risk low and aims to deliver returns roughly in line with prevailing overnight/short-term rates. (AMFI India)
How do they work?
- Your money is pooled and invested across very short-tenor instruments.
- NAV is marked to market daily.
- Redemptions are typically T+1 business day. Many AMCs also offer Instant Access Facility (IAF)—near-instant credit via IMPS/UPI capped at ₹50,000 or 90% of your invested value per day, whichever is lower. (PPFAS Mutual Fund, trustmf.com)
When should you use a Liquid Fund?
Ideal for short holding periods—about 7 to 90 days—such as:
- Parking a bonus or business receipts before planned outflows (taxes, vendor payments, property token, etc.).
- Staging a lump-sum into equity via STP (Systematic Transfer Plan).
- Building a layered emergency fund: keep 1–2 months’ expenses in a savings account for instant access and the next 3–6 months in a liquid fund (remember the IAF limit).
If your horizon is <7 days, consider an Overnight Fund (1-day maturity). For 3–6 months, an Ultra-Short Duration or Money Market Fund may fit. (AMFI India)
Liquidity, Exit Load & Access
- T+1 redemption is standard; check your AMC’s cut-off times and bank processing windows.
- Instant Access Facility (IAF): redemption up to ₹50,000 or 90% of folio value per day, whichever is lower. Useful for urgent needs but not meant for very large same-day withdrawals. (PPFAS Mutual Fund, trustmf.com)
- SEBI-mandated graded exit load for first 7 days (e.g., tiny basis-point charges if you redeem on Day 1–6; zero from Day 7). This discourages hot money and protects remaining investors.
Risks (yes, there are some)
While relatively conservative, liquid funds are not risk-free.
- Interest-rate risk: low due to ≤91-day maturity, but NAV can wiggle when rates spike.
- Credit risk: exposure to CP/CD varies by scheme; prefer portfolios with high A1+/AAA names and diversified issuer limits.
- Liquidity risk in stressed markets: mitigated by SEBI’s framework and the 7-day graded exit load.
For critical near-term payments, keep a buffer in a savings account. Use a liquid fund for the portion you don’t need instantly (beyond the IAF cap).
Expected Returns & How to Read Them
Liquid fund returns broadly track RBI’s short-term rate environment. They’re market-linked (not guaranteed) and vary with instrument yields.
Simple holding-period math:
If the scheme yields an annual rate rr and you hold dd days:
Approx. return≈(1+r365)d−1\text{Approx. return} \approx \left(1+\frac{r}{365}\right)^{d} – 1
Post-tax return (Growth option):
Post-tax=Pre-tax×(1−Your slab rate)\text{Post-tax} = \text{Pre-tax} \times (1 – \text{Your slab rate})
Taxation of Liquid Funds (FY 2025–26)
- Units purchased on/after 1 Apr 2023: Most debt schemes (including liquid funds) are treated as “Specified Mutual Funds”. All gains are taxed at your slab rate, regardless of holding period. (AMFI India)
- Dividends (IDCWs): Taxed at your slab in your hands; TDS @ 10% may apply if dividend paid by a fund exceeds ₹5,000 in a financial year. (AMFI India)
Related reading: How are Mutual Funds Taxed?; Direct vs Regular Mutual Funds.
Liquid vs Overnight vs Money Market vs Savings A/c
| Feature | Liquid Fund | Overnight Fund | Money Market Fund | Savings Account |
|---|---|---|---|---|
| Underlying maturity | ≤ 91 days | 1 day | ≤ 1 year | N/A |
| Typical use | 7–90 days parking; STP | <7 days | 3–12 months | Daily spends, emergency cash |
| Liquidity | T+1; IAF up to ₹50k/90% | T+1 (no IAF) | T+1 | Instant |
| Exit load | Graded for first 7 days | None | Usually none | None |
| Return profile | Near short-term rates | Near overnight rate | Slightly higher | Fixed bank rate |
| Taxation (post 1-Apr-2023 units) | Slab | Slab | Slab | Interest taxed at slab |
Sources for maturity definitions & scheme types: AMFI. Exit-load rule: SEBI/AMFI circular. IAF cap: AMC disclosures referencing SEBI Master Circular (2024). (AMFI India) (PPFAS Mutual Fund, trustmf.com)
How HNIs & Families Commonly Use Liquid Funds
- Treasury sweep: Park corporate/LLP current-account surpluses over weekends/fortnights; plan redemptions a day before payroll or GST dates.
- Staggered equity entry: Move lump-sum to a liquid fund, then STP into equity over 3–6 months to reduce timing risk.
- Property/ESOP proceeds: Earn market-linked yield while documentation closes.
Governance tip: Use Direct Plans to reduce expense ratio and insist on Growth option for simpler taxation. (See: Direct vs Regular Mutual Funds; Understanding Mutual Fund Ratings.)
What to Check Before Investing
Use the scheme factsheet/KIM to evaluate:
- Portfolio quality: % in T-Bills/G-secs vs CP/CD; top issuers; sector concentration.
- Average maturity & WAL: shorter = lower rate sensitivity.
- Expense ratio: lower costs help when yields are modest.
- AUM & liquidity profile: larger, well-diversified books can be more resilient.
- IAF availability and your bank mapping: if you need same-day cash within the IAF cap.
Step-by-Step: Parking Surplus for 45 Days (Example)
- Invest ₹10,00,000 in a Liquid Fund – Direct, Growth.
- Indicative gross annual yield: say 6.75%.
- Holding period return (45 days): (1+0.0675/365)45−1≈0.83%(1+0.0675/365)^{45}-1 ≈ 0.83\%.
- Post-tax @ 30% slab: 0.83%×(1−0.30)≈0.58%0.83\% \times (1-0.30) ≈ 0.58\% → ~₹5,800 net.
- Exit: Redeem on Day 46 (no exit load). If urgent mid-way, use IAF up to the daily cap. (PPFAS Mutual Fund, trustmf.com)
FAQs
Are liquid funds guaranteed or risk-free?
No. They aim for stability, but NAVs can fluctuate and credit events are possible. The 91-day maturity cap reduces—but doesn’t eliminate—risk. (AMFI India)
How fast can I get my money?
Standard redemptions are T+1 business day; IAF (if offered) enables near-instant credit up to ₹50,000 or 90% of your folio per day. Plan large redemptions a day ahead. (PPFAS Mutual Fund, trustmf.com)
Is there any lock-in?
No lock-in, but graded exit load applies for the first 7 days only; zero thereafter.
Growth or Dividend (IDCW)?
For most investors, Growth is cleaner. IDCW is taxed at slab and may attract 10% TDS beyond ₹5,000 in a year. (AMFI India)
Liquid fund vs fixed deposit for 2 months?
Liquid funds are market-linked with T+1 liquidity and potential to edge bank rates in certain cycles; FDs give fixed rate and premature withdrawal penalties. Choose based on rate, liquidity needs, and tax profile.
Bottom Line
For Indian investors—especially business owners and HNIs—liquid funds are a practical, efficient parking bay for short-term surpluses. They combine low duration, T+1 access (plus IAF for small urgent needs), and professional credit selection. Understand the 7-day graded exit load and slab-rate taxation post–April 2023, and use them thoughtfully within your cash-management plan. (AMFI India)