What is a Liquid fund?

The Ultra basics of Liquid Funds

The word ‘Liquid’ in the world of finance means something that is most easily converted to cash.

Liquid Funds are exactly that – Liquid.

So, a savings account is highly liquid.

A piece of property – Not so Liquid.

Stocks & Bonds – Mostly Liquid

Machinery & Equipment – Not so Liquid.

Therefore, Liquid funds are simply funds that have liquid financial products.

I.e – Investors can get cash by selling Liquid funds within 24 hours (Business hours).

To understand Liquid funds better, think about this :

There have only been two sources of capital. Ever. 

  1. Other people’s money (OPM)
  2. Your Money 

In the world of finance, simplicity has little value. 

So, obviously ‘other people’s money’ and ‘your money’ had to be called something more sophisticated. 

They started calling : 

‘Other people’s money (OPM)’ as Debt 

‘Your Money’ as Equity 

So, Debt = Other People’s Money = Borrowed money, right? 

But there are many forms of Debt too. 

Different borrowers have different needs. 

Some need money for long term projects such as building Roads, buildings, factories, infrastructure in general. 

Some (Corporations) need it for working capital requirements for just 1 night, 1 month, 2 months etc. 

Some need it for about 9 months to 1.5 years and some need it for 2-3 years. 

Some (Our Government) borrows for 10 – 30 years too. 

You get the point ! 

So, how does that affect everything? 

Well, the time frame for which the borrower borrows determines the riskiness of the loan to some extent. 

The longer the time of borrowing — the higher the uncertainty — and the higher the uncertainty — the higher the risk. 

and…Liquid Funds are just a bundle of loans. 

More specifically…

Liquid Funds are packages of loans given for periods upto 91 days. 

Types of Liquid Fund Loans (Debt Instruments)

Liquid fund loans can be of different types, For Example, the below given list contains at least 6 different types of loans upto 91 days (These types of loans are called Liquid Debt Instruments in the Financial world)

What is a Liquid fund? 1

Source : www.valueresearchonline.com

All 6 types of Securities have slightly different characteristics such as 

  1. Who issued them
  2. Interest rate being earned on them
  3. Timeframe for payback
  4. Whether loan is secured (by Collateral) or unsecured etc. 

To put it simply, they are all just loans. 

Debt Funds have 16 categories as officially described by SEBI but for simplicity’s sake we’ll consider the major 4 categories : 

  1. Liquid Funds
  2. Ultra Short Term 
  3. Short Term 
  4. Long Term Bonds 


Liquid Ultra Short Short TermLong Term
Maturity <91 Days91 days to 9 Months 1-3 Year 7 Years +
Risk
Min.

More than Liquid

More than Ultra short

More than Short Term
Interest Earned 
Min.

More than Liquid

More than Ultra Short

More than Short Term

So, Liquid funds are a basket of loans given to corporations and the government, for periods upto 91 days. 

That’s it. 

That’s great, but why should you invest in Liquid funds? 

Liquid funds are a great alternative to FD.

Generally, we keep funds in FD because : 

  1. We have Surplus Cash 
  2. Might need cash but don’t know when 
  3. Might need cash in a certain period etc. 

You should invest in Liquid funds because of exactly the same reasons given above. 

But why not FD? 

If you want to learn in-depth why Liquid funds are better than FD’s, checkout this article

But to keep it short and simple, Here are the 5 reasons why Liquid funds are a better FD’s. 

What is a Liquid fund? 2

To make it even more simple, there are 2 major advantages of Liquid funds over FD : 

  1. Tax advantages over 3 years (Tax payable = 20% with Indexation) 
  2. No TDS Deducted every year 

But is it really such a big deal? 

It is ! 

Tax advantage over 3 years and not having to pay 10% TDS on Interest earned is a very big deal.

And you can learn all about How Liquid funds give you a tax advantage, how to calculate tax and how Liquid fund indexation works and a lot more it in Liquid Fund Taxation – THE COMPLETE GUIDE

Ok, so now you know :

  1. What liquid funds are 
  2. Why they are useful 
  3. Who should invest in them (Anybody who invests in FD) 

But, now the question is…

HOW TO INVEST in LIQUID FUNDS? 

We have already understood what liquid funds are 

Why you should invest in them 

But before we find out HOW TO INVEST in LIQUID FUNDS, it makes sense to explore the simple question : 

How do you decide that a liquid fund is ‘Good’ or not? 

There are 41 Liquid funds available in India for Investors. 

This means you have to pick about 1 or 2 funds of the 41. 

How do you do this? 

5 simple rules of picking Liquid funds

  1. Pick fund with minimum 100 Debt instruments in it 
  2. Pick Fund with Min. 25% Sovereign bonds in it 
  3. Pick the ‘Direct option’ only 
  4. Expense Ratio of more than 0.20% is NOT Acceptable. 
  5. DO NOT pick the fund with the highest return*

*Most Mutual fund data website (For Example, www.valueresearchonline.com), ranks funds only on the basis of their past returns. We do NOT believe this is the right way to evaluate a Liquid fund or any other fund for that matter. 

Chasing returns can be a fatal mistake. 

One of the reasons why is that a liquid fund can earn higher than average returns when it invests in loans (Debt Instruments) that have a higher risk attached to them. 

If higher returns is really your motive with Liquid funds, maybe your reasons for investing in liquid funds are not clear. 

Liquid funds are supposed to be a safe parking place for your funds. 

Investors who are chasing returns alone should maybe look to invest in Equity. 

The point is, Don’t just look at Returns when it comes to choosing Liquid funds. 

Stick to the 5 Rules mentioned above and you should be fine. 

Now you can go and choose your Liquid fund here !

What is a Liquid fund? 3


Let’s see how you can actually invest in them. 

2 Simple steps to Invest in Liquid Mutual funds 

Step 1 : Get your KYC Done (Here’s How you can do it

*Example given is of SBI but you can follow the same procedure for any AMC*

  1. Fill up a KYC Form 
  2. Submit it to the nearest AMC branch if you have chosen a particular fund 
  3. OR Download CAMS KYC form from here and submit to nearest CAMS* center. 

*CAMS is a third party company that facilitates KYC services for Mutual fund. 

Step 2 : Once You are KYC Compliant. Visit AMC (Liquid fund company you have chosen) Website and simply sign up. 

Hope you found this article useful. If you have any questions/comments please let us know in the comments below. 

Thanks for Reading. 

Disclaimer :

  • The writer works with Mr. Varun Malhotra and EIFS. 
  • EIFS is an education company. We are not an advisory and therefore, no statements made in the article above or on this website in any form should be construed as investment advice. please consult your financial advisor before making any financial decisions.

9 comments on “What is a Liquid fund?”

  1. Excellent.

  2. Sir for debt part of portfolio which category should be choosen

  3. Sir, I have attended both Flap and flip courses. Thank you very much. I would like to know if the above rules for picking liquid funds ( debt instruments >= 100%, sovereign bonds >= 25% etc) can be applied to short term debt funds also.

    1. Sure, you can keep those in mind.

  4. Dinakar Praneeth says:
    Reply

    Thank you sir , Can you please tell me if one can apply the 5 simple rules being explained above be used for debt funds selection too (eg., Short term debt fund ) .

  5. Yes I am intrested in stock market biz and to enroll in this programme.

  6. Sir write a blog for Franklin liquid funds situation and how avoid this.

    1. Rahul EIFS Team says:
      Reply

      Thank you for the suggestion

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