Kiran, frustrated with the low returns on her savings account, turned to her friend Nandini for advice. Nandini introduced her to liquid funds, explaining that they are a smarter option for managing surplus funds. Liquid funds, as AMFI describes, invest in highly liquid money market instruments and short-term debt securities with residual maturities of up to 91 days. These include instruments like Treasury Bills (T-bills), Commercial Paper (CP), Certificates of Deposit (CD), and Collateralized Lending & Borrowing Obligations (CBLO).
Nandini highlighted the key features of liquid funds:
- their high liquidity, allowing redemption with funds credited within one working day (T+1);
- their safety, as they invest in high-quality, short-term securities; and
- their potential for optimal returns, often higher than savings account interest.
She also emphasised SEBI regulations that ensure transparency and security.
Intrigued, Kiran explored the digital investment process (Kuvera app) and shifted a portion of her savings to a liquid fund. Soon, she was impressed by the better returns and the convenience of quick access to her money. Her experience reflects a broader trend in India, where more investors are discovering the benefits of liquid funds (88% of the institutional investors and 12% of the individual investors-AMFI). These funds offer a balance of liquidity, safety, and growth, making them an ideal parking option for idle funds.
Let us also have a look at top 10 Liquid Funds of 2024 and key drivers behind growing popularity of the liquid funds in India:
Top 10 Liquid Funds With 1-Year Return
| S. No. | Name of the Fund | 1 Yr return (%) | TER (%) | Fund House |
|---|---|---|---|---|
| 1 | Edelweiss Liquid Growth Direct Plan | 7.52 | 0.08 | Edelweiss Mutual Fund |
| 2 | Aditya Birla Sun Life Liquid Growth Direct Plan | 7.48 | 0.21 | Aditya Birla Capital Mutual Fund |
| 3 | Bajaj Finserv Liquid Growth Direct Plan | 7.48 | 0.1 | Bajaj Finserv Asset Management Ltd. |
| 4 | DSP Liquidity Growth Direct Plan | 7.48 | 0.1 | DSP Mutual Fund |
| 5 | Sundaram Liquid Growth Direct Plan | 7.47 | 0.13 | Sundaram Mutual |
| 6 | Mahindra Manulife Liquid Growth Direct Plan | 7.47 | 0.16 | Mahindra Manulife Mutual Fund |
| 7 | Axis Liquid Growth Direct Plan | 7.46 | 0.15 | Axis Mutual Fund |
| 8 | Groww Liquid Growth Direct Plan | 7.46 | 0.1 | Groww Mutual Fund |
| 9 | Mirae Asset Liquid Growth Direct Plan | 7.45 | 0.09 | Mirae Asset Mutual Fund |
| 10 | Nippon India Liquid Growth Direct Plan | 7.45 | 0.2 | Nippon India Mutual Fund |
Source: Kuvera; December 29, 2024
The table lists the top 10 liquid funds in India based on their one-year returns. Edelweiss Liquid Growth Direct Plan leads with a return of 7.52% and the lowest TER (Total Expense Ratio) at 0.08%. Other notable funds, such as Aditya Birla Sun Life Liquid Growth Direct Plan and Bajaj Finserv Liquid Growth Direct Plan, offer competitive returns of 7.48%, with varying TERs. All the funds listed provide returns in the range of 7.45%-7.52%, making them attractive options for investors seeking liquidity and reasonable returns from trusted fund houses like Axis, Mirae Asset, and DSP Mutual Fund.
Key drivers Behind the Growing Popularity of Liquid Funds in India
(A) Liquid funds offer:
- high liquidity and flexibility with redemption processed in one working day (T+1);
- competitive returns (around 7.45%-7.52%).
(B) They ensure:
- low expense ratios (TER as low as 0.08%) and;
- safety by investing in short-term, high-quality instruments.
(c) They are:
- an excellent alternative to traditional savings accounts with better returns and comparable safety;
- digitally accessible, making investment and redemption seamless;
- popular among institutional investors
- suitable for risk-averse investors who prefer stability while earning reasonable returns on idle funds;
- managed by trusted fund houses, providing both stability and ease of investment;
- well-regulated by SEBI, ensuring transparency and mitigating risks.
Limitations of Liquid Funds
Like the popular saying ‘every coin has two sides’, liquid funds also have certain limitations which investors must be aware of. Some of them are:
1. Interest Rate Risk
Liquid funds invest primarily in short-term debt instruments. Changes in interest rates can affect the returns on these instruments, especially in a rising interest rate environment. Higher interest rates typically lead to lower bond prices.
2. Credit Risk
Liquid funds often invest in debt securities issued by companies or governments. The credit risk refers to the possibility that the issuer may default on its obligations, which could negatively affect the fund’s performance. Ensure the fund is diversified and invests in high-quality, low-risk securities.
3. Expense Ratio
While liquid funds are known for being low-cost, it’s essential to compare the expense ratio of different funds. A higher expense ratio can reduce your overall returns over time, even if the difference is small.
4. Inflation Risk
Returns from liquid funds might not always outpace inflation, especially if interest rates are low. If inflation is higher than the returns generated by the fund, your real returns may be negative.
5. Fund Manager
The performance of a liquid fund is highly dependent on the fund manager’s decisions regarding asset allocation and investment selection. A poorly managed fund can underperform, so it’s crucial to research the fund manager’s track record and investment approach.
6. Taxation
The returns from liquid funds are subject to capital gains tax. It’s essential to consider the tax implications when investing.
7. Market Conditions
In times of market stress or uncertainty, even liquid funds can face challenges. While they are generally considered low-risk, extreme market volatility can affect the returns and liquidity of the assets they hold.
8. Investment Horizon
Liquid funds are best suited for very short-term goals (up to 1 year). If you have a longer investment horizon, other types of funds (like equity or hybrid funds) can be looked at.
Wrapping Up
Liquid funds are a strong option for those looking to park surplus funds temporarily while earning better returns than traditional savings accounts. However, they may not be ideal for those seeking high returns over longer periods or who are looking for guaranteed returns. Like Kiran, investors should weigh the advantages against the challenges, consider their own financial goals, and invest in a well-managed liquid fund that aligns with their risk tolerance and investment horizon.
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