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Mutual Funds

Liquid Funds – Benefits, Taxation & Best Liquid Funds 2022

Written by - Akshatha Sajumon

February 3, 2022 10 minutes

Liquid Mutual Funds form an essential part of the open-ended debt mutual fund schemes. It is a short-term instrument where you invest in fixed income securities. It mainly focuses on money market instruments like commercial market, certificate of deposits, government securities, treasury bills, and term deposits. 

In India, mutual funds have a huge market. The Average Assets Under Management was ₹29,83,420 crore for the Mutual Funds industry in November this year.

Features of liquid mutual funds

  • A liquid mutual fund has a short tenure as it takes only a maximum of 91 days to attain maturity. 
  • What makes it unique is that the Net Asset Value(NAV) for the liquid fund is calculated for all 365 days, unlike other debt funds where NAV is calculated only for the working days.
  • Also, as the name suggests, these funds are highly liquid as there is no lock-in period, and users can enter or exit at any time. 
  • These funds offer higher return rates than a saving bank account and are quite safe to invest in.

What are the benefits of liquid mutual funds?

Investing in a liquid mutual fund has a wide array of benefits. Even though the returns received might be lower compared to equity investments, thousands of investors still prefer liquid mutual funds because – 

Higher returns than banks offerings

Most banks offer an interest rate of around 3.5% for savings accounts. Even the interests provided on a long term investment like a fixed deposit hovers around 2.75% to 7%. Once we consider these, it is quite practical to invest in liquid mutual funds whose returns vary between 7- 9% on average. 

No lock-in period

 It is effortless and quick to withdraw liquid mutual funds. It is like purchasing and selling equities. The credits of the redeemed unit are transferred to your account in 1-2 days. 

No entry and exit loads

 There are no timeframe or penalties for entry or exit loads. In other words, you can enter or exit the scheme at any time. The only criterion is that the investor must hold the fund for at least seven days before the exit. 

Low-interest rate risk

 The investment in a liquid mutual fund has a very low-interest rate risk. This is mainly because your funds are invested in instruments with very high credit rates and guaranteed growth prospects.


Liquid mutual funds are an excellent way to diversify your investment. You can combine this with equity investments and government bonds to enjoy a perfect combination of security, returns, and liquidity. Investors also can transfer the funds to an STP after their maturity, adding to the diversification.

Low Expense Ratio

All funds attract an annual fee for offering fund management services. This is known as the expense ratio. Investors often prefer those which have a low expense ratio as it can maximize their gains. An expense ratio typically varies between 0.5% to 1.5%. Anything between this number is considered nominal. Most fund managers keep the liquid fund securities until maturity. This means there won’t be any significant expense due to the buying and selling of the securities. It directly has a positive impact on the expense ratio, keeping it very low for most liquid mutual funds.

Who should invest in liquid funds?

Liquid funds are an ideal option for any investor looking for high liquidity, low risk, and high returns. If you have a sum of money lying idle in a bank getting minimal returns, you can choose to invest in liquid mutual funds instead. Investing in a liquid mutual fund is also a good idea for those investors who have received a surplus fund in the form of capital gains, gifts from family, or incentives. It acts as a good investment avenue for the interim before you invest these proceeds into other long-term investments.

It is common to see an investor who has invested in a liquid mutual fund opt for a Systematic Transfer Plan into a long-term investment plan like equity mutual funds.

An example scenario where liquid mutual funds help

Prakash works for a technology company. He receives a lump sum bonus of 5 lakh INR from his company for his exceptional performance. Prakash plans to invest this amount to get high returns. At the same time, he might need a part of this amount after 3-4 months for his marriage. In short, he needs high returns without compromising on the liquidity. Putting the amount in a savings bank account offers liquidity, but the returns are low. For most banks, it lingers around 4%.

Prakash consults his friend, who advises him to invest in a liquid mutual fund scheme with top-quality debt securities. And the maturity of the funds is only 91 days, thereby ensuring that Prakash gets the amount bank into his account at the time of need. The fund also offered 8% returns, which was twice the returns from a savings account. The fund’s security is also guaranteed since the interest rate doesn’t fluctuate drastically due to a shorter maturity period. 

Ultimately, a  liquid mutual fund turned out to be the perfect investment option for Prakash. 

How are liquid funds taxed?

In a liquid mutual fund, the dividends received are tax-free. However, the returns are taxable. There are two ways one can be taxed while investing in liquid mutual funds – 

  • Short Term 

If the redemption on mutual funds is before three years, the gain is considered as short-term capital gains. This is taxed as per the applicable tax slab rate. 

  • Long Term

If the investor beyond three years holds on the investment, it is taxed under long-term capital gains, 20% with indexation.

How to choose the right liquid mutual fund?

It is essential to choose the right liquid mutual fund to gain what you hoped for. But there are few things to consider before you choose a liquid fund – 

Historical Returns

It is essential to check the fund’s performance in the past. If the funds seem to have performed well in the past by outperforming their benchmarks. It is also necessary to check the Asset Management Company(AMC) record before investing in the liquid fund. Ultimately, an AMC is responsible for driving the mutual funds and making decisions that benefit the investor.


Although liquid mutual funds are relatively less risky than their equity counterparts, there are certain risks associated with liquid mutual funds. There may a drop in the credit rating of the securities in which the liquid funds are invested in resulting in a drop in the value

Average Maturity

 Investors prefer liquid mutual funds due to their short-term maturity. So it is essential to invest in liquid funds with minimal maturity, preferably less than 91 days, which is the maximum value. Due to a shorter tenure, there won’t be any significant fluctuation in the interest rate, and you won’t get any significant shocks during maturity.

Expense Ratio

As we saw earlier, it is merely the amount that you need to pay to the fund house to manage your investment. The higher the ratio, the lower is your profitability. So choose a fund with a low expense ratio to get the maximum out of your investment.

Investment horizon

Your investment horizon needs to match the maturity term of liquid funds. If your investment horizon is for the longer-term then equity mutual funds or balanced funds may suit you better. Liquid funds work well for shorter terms.

Top liquid mutual fund recommendations 

These are some of the best performing liquid mutual funds based on past performance. 

ICICI Prudential Liquid Fund

About Fund

The scheme aims to generate reasonable returns by maintaining a low-risk profile of the portfolio and a high level of liquidity. The fund invests 80% of its corpus in money market securities and the remaining is invested in high-quality debt instruments.

Inception DateJanuary 02, 2013
Benchmark NameCRISIL Liquid Fund Index
Fund ManagerRahul GoswamiRohan Maru
Expense ratio0.20%
Fund typeOpen-ended
RiskLow to moderate

Historical Returns of the Fund (annualised)


Aditya BSL Liquid Fund

About Fund

The scheme aims to offer investors high liquidity and low-risk investment opportunities combined with reasonable returns. It primarily invests in debt and money market instruments.

Inception DateJanuary 02, 2013
Benchmark NameCRISIL Liquid Fund Index
Fund ManagerSunaina da CunhaKaustubh Gupta
Expense ratio0.21%
Fund typeOpen-ended

Historical Returns of the Fund (annualised)


HDFC Liquid Fund

About Fund

The scheme aims to generate income by setting up and maintaining a portfolio, primarily comprising money market and debt instruments. It is best suited for investors who have a very short-term investment horizon and are looking for alternatives to bank deposits.

Inception DateJanuary 02, 2013
Benchmark NameCRISIL Liquid Fund Index
Fund ManagerAnupam Joshi
Expense ratio0.20%
Fund typeOpen-ended
RiskLow to moderate

Historical Returns of the Fund (annualised)


Kotak Liquid Fund

About Fund

The scheme aims to provide reasonable returns while maintaining a high liquidity level by investing primarily in money and other short-term debt instruments. It is ideal for investors who have a low-risk appetite and short investment time horizon.

Inception DateJanuary 01, 2013
Benchmark NameNIFTY Liquid Fund Total Return Index
Fund ManagerDeepak Agrawal
Expense ratio0.20%
Fund typeOpen-ended
RiskLow to moderate

Historical Returns of the Fund (annualised)



Liquid mutual funds are an excellent investment instrument for all types of investors. Due to its liquidity and security, it is a go-to option for most people who have big plans within a short period. But remember, you can invest in a liquid fund only for a short period of 3 months or lesser. As an investor, you must plan what to do next after the liquid funds’ maturity.


When should investors invest in liquid funds?

Investors can consider investing in liquid funds during rising interest rates, as rising rates do not impact liquid funds and these offer higher liquidity during such scenarios.

Which is better, bank FDs or liquid funds?

Liquid funds can offer inflation adjusted returns while allowing a risk-return balance as compared to bank FDs that may offer lower returns.

How to select the right liquid fund for investment?

While selecting a liquid fund, investors can look at the fund’s credit rating, historical performance, expense ratio, and ensure that the selected fund’s objective is in line with the personal investment objective.

How can I liquidate my investment in a liquid fund?

Many liquid funds offer instant redemption feature allowing investors to liquidate their investment.

Is there a lock-in period in liquid fund investments?

No, there is no lock-in period to be followed for liquid fund investments and investors can withdraw their investment at any time.

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