What Are Liquid Funds? Easy Guide for Beginners

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Whether you are an active investor, or just looking to park your funds somewhere it can grow while still being accessible, liquid funds can be a great option. They can be used for various purposes, from building an emergency fund to increasing your savings while taking advantage of market trends. In this guide, we cover what liquid funds are, how they function and how you can invest in the best liquid funds.

What is a Liquid Fund?

A type of debt fund, liquid funds are mutual fund schemes that primarily invest in assets that are safe and have high liquidity. This is ideal for investors who are looking for short term and stable returns on their investments. It is common for active investors to have liquid mutual funds as a part of their mutual fund portfolio for diversification and balance.

Where Does a Liquid Fund Invest?

Investments made by liquid funds are made in securities with shorter maturities and comparatively stable values:

• Treasury Bills(T-bills)
• Commercial Paper (CP)
• Certificates Of Deposit (CD)
• Collateralized Lending and Borrowing Obligations (CBLO)

These financial instruments have a maturity of up to 91 days, however, an investor can continue to stay invested in the Liquid mutual fund even after the maturity period.

How Do Liquid Funds Work?

Liquid Funds aim to provide returns with minimal risk by investing in high-quality instruments, here’s a brief overview of how Liquid Funds, as a type of debt funds function:

1. Investors contribute money to liquid mutual funds, which are subsequently overseen by a fund manager.
2. The Fund manager then invests in short-term debt/ money market securities which have a maturity period of 91 days.
3. The return on these investments comes from the interest income on the asset performance.
4. These returns are reflected on the Net Asset Value (NAV) of the liquid mutual fund. Investors can choose to keep the funds growing or redeem it for payout. If selected for redemption, the funds are disbursed within the same or next day.

Features and Benefits of Liquid Funds

If you are considering investing in Liquid Funds, it’s important to know the features of this mutual fund and how it fits in your overall portfolio:

1. Short Term Investment: If you are looking to grow your investments with a shorter horizon, Liquid Funds invest in securities that mature in less than three months. Therefore, you can see a steady increase in your investments with minimal market risks.

2. High Liquidity: One of the main advantages of liquid funds is that they make your investment accessible, in most cases your redemption requests can be processed within 24 hours of a business day.

3. Low Risk: Liquid funds are a good choice for investors who have low to moderate risk appetite as these mutual funds only invest in securities like treasury bills, government bills and other short-term securities.

4. No Exit Load (Typically): Liquid funds are not as actively managed as other debt mutual funds, which is why these funds have lower expense ratios leading to more returns on your investments.

5. Better Returns than Savings Account: Liquid mutual funds generally offer better returns than savings accounts since these mutual fund schemes invest in money market instruments with short-term maturity. This gives it the advantage to get higher interest rates while maintaining liquidity.

6. Tax Efficiency (for Holding Over 3 Years): If the units are sold or redeemed within three years of purchase, the gains are taxed as per the income tax slab rate of the investor.

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Who Should Invest in Liquid Funds?

Liquid funds are ideal for individuals and entities who:

• Require access to their investment: They are a great choice for keeping emergency funds, excess cash, or funds required for short-term objectives (e.g., car down payment, holiday, future bill payments) as redemptions are usually done within one business day, and some have instant redemption.
• Want higher returns than traditional investment options:  Liquid funds have the potential to generate higher returns compared to a regular savings account, fixed and recurring deposits, since the interest rates are linked to the market performance.

Also Read: Best Tax-Saving Mutual Funds & Investment Options 2025

Associated with Liquid Funds

While Liquid Funds are positioned to be a safe choice for investors, it’s important to note that it is not risk-free. Here are some risks you should be aware of when investing in Liquid Funds:

1. Credit Risk: Since liquid funds invest in bills and certificates securities. However, there’s a chance that these financial instruments may default on repayment. Such defaults can affect the returns on your investment since the Liquid fund’s NAV reduces.
2. Interest Risk: Liquid funds are exposed to the market trends, which means the interest rates can fluctuate on your Liquid Fund’s returns. While you might see an interest rate for liquid fund it is not a guarantee of how much you will earn on your investment.
3. Inflation Risk: Liquid fund returns may not always keep pace or overcome the inflation rate.

Taxation and Charges on Liquid Funds

To optimize your investments in Liquid Funds, it’s important to know the taxation and the fees applicable to Liquid Fund investments.

Tax on Liquid Funds in 2025

Your liquid assets are subject to holding period taxation in 2025. Here’s a breakdown on how liquid fund investments are taxed as per the current tax regime:

Fees Charged on Liquid Funds

• Expense Ratio: Annual Management Fee (AUM), generally less than 1%.
• Exit Load: If redeemed within seven days of investment, the exit load is negligible (e.g. 0.007% to 0.0045%).
• TDS: 10%, if dividends earned exceeds INR 5,000.

How to Invest in Liquid Funds?

1. Step 1: Choose a liquid fund by comparing their returns, expense ratios and if they have conditions or charges for the redemption of funds.
2. Step 2: Consider investing through a trusted and secure investment account, making the process quick. Make sure your KYC information is current.
3. Step 3: Choose between SIP or Lump sum mode of investment.
4. Step 4: If you wish to redeem funds, you can withdraw funds. Keep in mind there can be an exit load charge incurred if the amount is withdrawn within the first 15 or 30 days.

Top 5 Liquid Funds

To help you in identifying the best liquid mutual funds, refer to this list of top liquid mutual funds for 2025 based on publicly available rankings.

Please Note:

• Returns stated are as of May 29, 2025.
• AUM = Assets Under Management; CPs = Commercial Papers; CDs = Certificates of Deposit.
• 2-Year CAGR not available for Bajaj FinServ Liquid Fund due to recent launch.
• Past performance is not indicative of future returns.
• Investors are at sole discretion on investment decisions. DBS Treasures does not endorse or suggest these mutual funds for investment.

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Conclusion

Liquid Funds is a good alternative if you want to invest in a low-risk asset with exposure to market trends or balance your portfolio. Being aware of its features and how it functions will help you to make smart investments.

With DBS Treasures, you can grow your wealth in a safe and secure way. You can even consider opening a DBS Bank premium savings account and leverage the benefit of a dedicated team of relationship managers and wealth experts.

Disclaimer: The information provided is for informational purposes only and should not be construed as financial advice. Please consult with a financial advisor before making any investment decisions.