Liquid funds are debt mutual funds that invest in short-term debt and money market instruments. These funds have a very short maturity period of up to 91 days. They are a suitable option for money you may need after 2-3 months. Liquid mutual funds are also often used as emergency funds, as they can be redeemed quickly and easily.

Instead of letting your money sit in a bank, many prefer to invest in this type of low-risk debt mutual fund.

Liquid funds can make a good investment option if you:

• Have short-term surplus money: If you have extra cash lying around for a few days, weeks, or months, you can put it in a liquid fund. Instead of letting it sit idle, you can earn interest while keeping your risk low. For ultra-short-term investments, like a day, you also can consider overnight funds.
• Want an alternative to a savings account: Liquid funds usually offer a slightly higher rate of return compared to a bank savings account, without locking your money. They help you earn more on everyday idle cash.
• Need easy access to your money in an emergency: If you want to be able to withdraw your funds quickly, without any hassle, you can consider liquid funds to invest in. Redemptions are usually processed within one working day. Many funds even offer instant withdrawal up to ₹50,000.
• Want to park money before another investment: Let’s say you have a lump sum that you want to invest in equity funds gradually. You can park that full amount in a liquid fund first. Then, set up a SIP to invest it over time.
• Have a short investment horizon: If your financial goal is only 1 to 3 months away, you cannot afford the risk of price fluctuations that come with stocks or long-term bonds. In that case, liquid funds can protect your capital for a brief period.

A liquid fund pools money from many investors. The fund manager then lends this money to the government, banks, or large companies for a short duration (up to 91 days). In return, the fund earns interest every single day.

The interest earned steadily increases the fund’s net asset value (NAV). And since the underlying loans last only 91 days or less, changes in market interest rates barely have any impact on a liquid fund’s value, making it less volatile.

Let’s understand with a practical example.

Imagine you have surplus cash of ₹5,000 and instead of letting it sit in your pocket, you decide to invest in a liquid fund. Now, if the NAV of the liquid fund you choose is ₹20, you can buy 250 units (₹5,000 / ₹20).

As interest adds up, the fund's NAV rises to, let’s say, ₹20.40. Your 250 units are now worth ₹5,100 (250 units x ₹20.40). You earned ₹100 on your investment.

If the underlying borrower fails to pay interest or repay the principal, the liquid fund’s NAV can be negatively affected.

Liquid funds are mainly about flexibility. But there are more benefits on offer, such as:

• High liquidity: You can withdraw your money at almost any time, with some funds offering instant withdrawal up to ₹50,000.
• Low interest rate risk: Since the duration is short, changes in the RBI’s interest rate policy don’t have a major impact on the fund’s value. The investment remains less volatile.
• Better returns than a savings account: They generally offer higher interest than a regular savings bank account. Your idle cash works harder without taking on heavy risk.
• No lock-in period: Your money is not tied down for months or years. You are free to invest for as little as a few days or a few weeks.
• Ideal for parking backup cash: It is generally considered a safe investment option for keeping your backup savings. You can earn returns while keeping the money easily accessible for emergencies.

Liquid funds are relatively short-term debt investments, but they still come with some risks, such as:

• Credit risk: The fund manager lends the pooled money to companies and banks. Now, if the borrower delays repayment or doesn’t pay at all, the manager has to write off the loss. This can cause the fund’s NAV to drop.
• Reinvestment risk: As loans mature quickly, the fund manager has to constantly look to reinvest at current market rates. If the interest rates drop, the returns you earn may also decline.
• Liquidity risk during panic: If there’s panic in the market and all the investors pull out their money at the same time, the fund might face a severe cash crunch. However, mutual funds keep 20% aside for such events.
• No fixed return guarantee: Unlike a bank savings account or FD, liquid funds don’t offer a guaranteed fixed return.
• 7-day exit load penalty: If you redeem within 7 days, you'll pay a small exit fee. So, if you are planning to park money for just 2 or 3 days, you can explore other options such as overnight funds.

Note that the Securities and Exchange Board of India (SEBI) makes it compulsory for liquid funds to conduct regular stress tests for sudden panics. This shows even a short-term debt fund should not be treated as completely risk-free.

These 3 debt funds are often preferred for short-term investments. Let’s compare them across parameters like liquidity, risk, and returns to understand which is the better choice for you.

Liquid funds and savings accounts are often compared because both can hold money you may need in the near future. However, both work very differently. As you know, a savings account is a bank deposit that earns interest. A liquid fund, however, is a market-linked mutual fund that invests in short-term securities.

Here’s a quick comparison between the two:

A savings account is still important for everyday expenses and emergency cash. A liquid fund is a different product with a different purpose. Don’t pick one simply because its potential return looks higher.

Choosing the best liquid funds isn't about high returns. It is about safety, low cost and instant access to your money. Here are a few things to check before investing:

• Prioritise high credit quality: Look for funds that lend primarily to the government or top-tier banks. Check that the portfolio holdings include A1+ or AAA-rated securities. Don’t compromise on safety for a slightly higher return.
• Check the fund’s AUM: Pick schemes with a larger fund size, as they can easily absorb heavy withdrawal requests without facing liquidity issues.
• Compare expense ratio: The expense ratio is an annual fee taken from your returns. Since liquid funds earn small gains, even a 0.20% fee can make a difference. Prefer direct plans with a lower expense ratio.
• Look for instant redemption: If you are keeping an emergency fund here, check whether the fund allows instant redemption. This lets you withdraw up to ₹50,000 instantly, anytime.

Liquid funds are built for a particular job. They are not meant for every goal. If your goal is many years away, you may need to explore other categories such as equity funds, hybrid funds or index funds, depending on your risk appetite.

Once you’ve decided that a liquid fund fits your needs, getting started on Millions is easy:

• Download the Millions app from the Google Play Store or iOS App Store.
• Enter a few details to open a free demat account.
• Complete your KYC on the app.
• Log in and explore the curated mutual funds.
• Look for debt-fund options and select a liquid fund that fits your needs.
• Choose how you want to invest. You can select a lump sum or, where available, use a SIP.
• Enter the amount and review all the details before completing the payment.

And you’re all set. Investing your idle cash doesn’t have to be complicated. A liquid fund does the rest. You can track your investment on the dashboard and withdraw whenever you need.