What is a Liquid Fund – Meaning, Risks, Returns & Taxation

People often have extra money or look for better returns with less risk. But striking this balance is not easy. Still, they can manage it smartly. First, they can invest for a short time until they find a good chance to enter the markets. Second, they can stay invested longer than traditional options like fixed deposits. A liquid fund can help balance return and risk for any time frame. In this article, we’ll understand what is liquid fund, how it works, its features, and more. Keep reading to learn more.

Liquid Funds Meaning

A liquid fund is a type of mutual fund where your money gets invested mostly in short-term securities like treasury bills, certificates of deposit, or commercial papers. These things are quite safe and often deliver better returns compared to a savings account. People use liquid funds to park extra cash for a short time frame, like a few days to a few months. You can withdraw funds anytime. 

Although it doesn’t deliver very high returns, as it depends on the risk undertaken. This is one of the methods to earn better returns rather than keeping money idle in your bank account. It’s simple and good for short-term needs or emergencies. We will see how liquid funds work.

How Does a Liquid Fund Work?

We now know that in a liquid fund, there will be short-term, high-quality debt and money market instruments like treasury bills, commercial papers, certificates of deposit, and overnight money market deals. So, fund managers pick these instruments because they mature quickly, usually within 91 days or less, so they keep the fund stable and reduce volatility from potential interest rate swings.

When you invest in a liquid fund, the fund house pools your money with other investors' money and buys these short-term papers. Every day, the market value of the fund is evaluated on a daily basis to arrive at the Net Asset Value (NAV), and it’s disclosed for every working day.

You earn returns in the form of small daily gains, which add up over time. These funds don’t promise fixed returns but mostly stay steady because the underlying papers are very low-risk. If a company or bank issues commercial paper, the fund buys it and earns interest for lending money for a short time.

When you are in need of funds, you can place a redemption request. The fund house sells your invested value from part of its holdings. The liquid funds can return your money in about one or two working days, which makes them very handy for emergencies.

The main goal of a liquid fund is to keep your money safe, give slightly better returns than a savings account, and often earn slightly better returns compared to an FD. So, the fund house lets you pull money out quickly when you need it. This is why people use liquid funds to park idle money for a few days to a few months without locking it away like an FD. As per SEBI’s rules, liquid funds must hold only very short-term and highly rated debt to keep them safe for investors. 

Features of Liquid Fund

As we looked into how liquid funds work, we will look at some of the features of it, and here are some of the following:

• Short-Term Investment: These funds invest your money in short-term debt papers like treasury bills, certificates of deposit, and commercial papers. These mature in 91 days or less, so your money stays safe, and it is easy to access.

• Liquidity: You can withdraw your funds anytime. Most liquid funds credit the money back to your bank within 1 or 2 days, so you get quick cash when you need it.

• Risk Factor: Liquid funds invest only in top-rated, short-term instruments, which are less likely to default. This lowers the chance of losing capital compared to long-term debt or equity funds, which possess very high risk.

• Lock-In Period: You don’t have to stay invested for a fixed period. You can park money for even one day or a few weeks. Funds may charge a small exit load if you withdraw within 7 days.

• Returns Aspect: Returns are better than savings accounts and often beat fixed deposit returns as well. When compared to shares, it underperforms due to the nature of the risk undertaken. Liquid funds stay steady because the fund’s money is in safe, short-term papers, so market swings would barely affect those.

• Cost Factor: Liquid funds have low expense ratios, which are usually below 1 percent. This means the fund house charges very little to manage your funds, so you can keep most of what you earn.

What Are the Typical Liquid Fund Returns in India?

The liquid fund returns are typically higher than savings account but often higher than fixed deposits by some small percentage variations or basic points. Liquid fund interest rate usually fall in range of 6% to 7% on average, which is higher than a normal savings account but lower than long-term or equity funds. Many good liquid funds have delivered around 7% in the past year and about 6.8% to 7% over two to three years. 

These funds invest in safe, short-term debt papers, so they keep returns steady without much volatility. As an investor, you need to assess based on your risk profile and make decisions that match your goals. It is another type of investment to earn higher returns, but it hardly creates wealth in the long term.

Advantages of Liquid Funds

The advantages of liquid funds include quick access, better returns than a savings account, low risk, and more. Here are some key benefits explained below.

• Quick Access: You can withdraw money anytime, and the funds are usually transferred to the bank within 1 or 2 days. This makes liquid funds ideal for handling emergencies or parking money temporarily without locking it away like in fixed deposits.

• Better Than Savings: These funds generally deliver higher returns compared to a savings account. So instead of keeping funds idle in your bank, you can earn higher returns by keeping them in a liquid fund while still accessing them easily.

• Low Risk: They invest in short-term, high-quality instruments like treasury bills and commercial papers. These are considered safe, so the chance of losing money is much lower compared to equity or long-term debt funds.

• No Lock-in period: There is no fixed holding period or lock-in. You can take your money out anytime without penalty (except for the first 7 days in some cases), giving you full flexibility over your funds.

• Low Cost: Expense ratios in liquid funds are low, which means the fund doesn’t charge you much to manage your money. This helps you keep more of the returns generated over time.

• Stable Returns: Liquid funds usually give steady returns that don’t fluctuate much. They avoid long-term risks and are not affected by market volatility like equity funds, making them good for short-term stability.

Disadvantages of Liquid Funds

While liquid funds offer several benefits, it's important to be aware of their limitations too. Here are some of the key disadvantages of liquid funds:

• Low Returns: Returns are higher than savings accounts but lower than equity or other long-term funds. If you're aiming for wealth creation or big profits, liquid funds aren’t the right choice.

• Taxable Gains: Gains from liquid funds are taxed differently. During the income tax filing period, the liquid fund gains will be taxed according to your income slab. This tax can be less beneficial, especially for people in higher tax brackets.

• Not Risk-Free: Despite being safer than equity funds, liquid funds still carry interest and credit risk. If a company defaults or economic conditions worsen, your returns may drop or face temporary losses.

• Exit Load Risk: Some liquid funds charge a small exit load if you withdraw money within 7 days of investing. This can impact your returns if you redeem too early. You can plan your investments wisely.

• Short-Term Only: Liquid funds are not meant for long-term goals like retirement or buying a house. They are best used only to manage cash for short durations or emergencies.

• Returns May Vary: Even though they are stable, returns can still go up or down depending on changes in interest rates or money market conditions. So, there’s no fixed guaranteed return.

Liquid Funds vs FD vs Savings Account

As we looked into the advantages and disadvantages of liquid funds, we will differentiate liquid funds from savings accounts and fixed deposits, and in the table below are some comparable points:

When Should You Use a Liquid Fund?

You can look at a liquid fund as an option when you have some spare money that you don’t need for daily use. For example, you can keep your emergency money here instead of just leaving it in your savings account. It’s also good when you wait to pay big expenses like school fees, house repairs, or buying a new gadget in a few months.

If you sold a property or received a bonus and want to park that money for a short time before you decide what to do, you can look at a liquid fund as an option. It can deliver you better returns than a savings account, keep risk low, and you can withdraw money out quickly, mostly in one or two days. So, use a liquid fund when you want to earn an extra return, but do not use it for long-term goals because it is not suited to grow long-term wealth.

List of Liquid Funds to Invest in 2025

Here is the list of Liquid Funds based on AUM that you can consider investing in 2025.

Note: The above data is considered as of 26th June 2025. These are subject to market changes. 

How to Invest in Liquid Funds

To invest in a liquid fund, one needs to go through simple steps, and here they are as follows:

• Get the Rupeezy app to pick top mutual funds that match what you want and how much risk you can handle.

• Finish KYC verification by providing necessary documents.

• After verifying your KYC, your account is opened for investing.

• Open the ‘Explore’ section to see all types of funds available.

• Choose ‘Debt’ under Popular Categories.

• Check the risk and return using the easy-to-read graph and switch to ‘List View’ to look at each fund in detail.

• Compare funds by looking at past returns, risk level, size of the fund (AUM), and expense ratio.

• Choose your funds accordingly and decide if you want to invest lumpsum or start a SIP.

• Enter the amount you want to invest and pay using UPI or net banking.

• From the respective fund house, your fund units get allotted in 1–3 working days.

How Is Tax on Liquid Funds Calculated?

Liquid funds offer high liquidity and steady, low-risk returns, making them a popular choice for investors looking to park extra cash. However, it’s essential to understand how taxes work on the gains you earn from selling the units.

Earlier, the holding period was the deciding factor, and based on that, you had different tax rates for short-term and long-term capital gains. Now, from April 1, 2023, all gains from debt mutual funds, including liquid funds, count as short-term capital gains, no matter how long you hold them.

1) Short-Term Capital Gains (STCG)

If you redeem the liquid fund units anytime, like within 3 months or 3 years, your gains are treated as STCG. The gain is added to your total income and taxed as per your income tax slab.

For example, if you are in the 20 percent tax slab and the gain is Rs. 1,000 from liquid funds, you pay Rs. 200 as tax.

2) Long-Term Capital Gains (LTCG)

Effective from April 1, 2023, LTCG does not apply to liquid funds because all gains are taxed as STCG. Earlier, if you held debt funds for over three years, you paid 20 percent tax with indexation. Now, this benefit is removed.

If you had invested in dividend-paying liquid funds, that income would be added into your total income and taxed at your slab rate, too. If your total dividend in a year is more than Rs. 5,000 from that particular fund house, they deduct 10 percent of TDS on the excess crossing the required limit.

Conclusion

As we arrive at the conclusion of the article, we understood what is liquid fund, its features, workings, and other details. Liquid funds offer a smart way to park extra money for short periods while earning better returns than a savings account and sometimes even a fixed deposit. They combine safety, easy access, and steady returns, which makes them useful for emergencies or when waiting to invest elsewhere. However, they aren’t meant for building long-term wealth. Always check your risk level, compare options, and understand how taxes apply before investing, or consult a financial advisor to make informed decisions.

FAQs:

Q1. Which is better: Overnight Funds or Liquid Funds?

Pick overnight funds for one-day for parking the fund. You can choose liquid funds for better returns if you plan to invest for a few days to months.

Q2. What is the exit load on Liquid Funds?

Pay a small exit load if you withdraw within 7 days. After 7 days, no exit load applies.

Q3. What is the redemption time for Liquid Funds?

Get your money back in 1–2 working days after you redeem.

Q4. Where do Liquid Funds invest?

They invest in treasury bills, commercial papers, certificates of deposit, and other short-term papers.

Q5. How to choose the best Liquid Fund?

Check past returns, low cost, fund size, risk, and match it with your goal.