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- What are Liquid Funds?
- What are Debt Funds?
- Liquid Fund vs Debt Fund: Key Differences
- Debt Fund vs Liquid Fund: In Detail
- Debt Fund Vs Liquid Fund: Which is A Better Investment?
While choosing to invest in mutual funds, there is often confusion for investors between debt funds and liquid funds. A debt fund is a broad mutual fund category that invests its collective pool of money in fixed income securities. In contrast, a liquid fund is a subset of a debt fund scheme. This article will discuss the difference between a liquid fund and a debt fund (liquid fund vs debt fund) in detail.
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What are Liquid Funds?
A liquid fund is an open-ended debt mutual fund that invests in debt securities with a maturity of fewer than 91 days. In simple words, a liquid fund is a subset of a debt mutual fund. The fund portfolio invests in debt instruments that are of high credit quality. They invest in money market instruments like certificates of deposits (CD), treasury bills(T-bills) and commercial paper (CP) for up to 91 days. Unlike any other debt funds where the NAV of the fund is calculated only on business days, liquid funds NAV is calculated for 365 days.
Liquid funds are highly liquid in nature and have no lock in period. In other words, this fund has no entry and exit load. Also, the risk associated with liquid funds is the least compared to other classes of debt mutual funds. Furthermore, liquid schemes can give better returns than savings bank accounts. Therefore, individuals having idle funds lying in their bank account can park them in liquid funds to earn better returns.
Recommended Read: Mutual Funds with No Exit Load
What are Debt Funds?
A debt fund is a mutual fund scheme that invests in fixed income generating instruments with lesser risk and lesser volatility. Some of the fixed income instruments are Certificate of deposit, Corporate Bonds, treasury bills, commercial paper, government securities and many more. Debt funds are also known as Bond Funds or Fixed Income Funds.
The major objective of debt funds is to provide regular and fixed interest during the investment period. Also, it aims for capital appreciation for an investor. Debts funds can be classified into various categories based on the maturity of the underlying securities of the fund portfolio. Some of them are liquid funds, ultra short term funds, gilt funds, income funds, corporate bond funds, dynamic bond funds, etc.
The selection of assets for a debt fund is based on the credit rating. When the credit rating is higher, it gives a higher assurance that the interest payment is regular and the principal amount invested is repayable upon the maturity of the investment. Thus, these funds are a better option than the traditional investment options like bank deposits and savings bank accounts.
Liquid Fund vs Debt Fund: Key Differences
Following are the differences between liquid funds and debt funds:
| Basis of Difference | Liquid Fund | Debt Fund |
| Investment Objective | Invest in debt and money market instruments with a maturity of up to 91 days only. | Invest across a wide range of debt instruments. |
| Average Maturity | 91 days only | No restriction |
| Risk | Very Low | Relatively higher than liquid funds. |
| Returns | Stable returns | Fluctuate depending on the prevailing interest rates. |
| Liquidity | Highly Liquid | Not as liquid as liquid funds. |
| NAV Determination | Calculated for all 365 days | Calculated only on business days. |
Debt Fund vs Liquid Fund: In Detail
The following are the key parameters that show the differences between liquid funds and debt funds.
Average Maturity
The first and most important difference that can be made between liquid funds and debt funds is the average maturity of the underlying securities. Liquid funds invest in fixed income securities that have a maturity period of 91 days. Also, these securities are held till the end of maturity.
For debt funds, there is no restriction on the maturity term. The average maturity for the debt funds varies based on the fund category. Thus, the maturity profile of the underlying securities of the debt fund portfolio can be a combination of both short and long term instruments based on the fund’s underlying objective.
Risk
Comparatively, the risk component in liquid funds is very low. The reason is, the average maturity tenure of the underlying securities is low. As a result, the interest rate risk and credit risk attached to these funds are also minimum. Also, the securities are held till the end of maturity instead of trading.
In the case of debt funds, they carry higher interest rate risk and credit risk. Hence, one must evaluate these funds before investing in them.
Returns
The liquid funds have a shorter term, and hence the interest rate fluctuation is very less. Therefore, these funds tend to deliver stable returns.
For debt funds, the returns of the fund fluctuate depending on the interest rate movements in the country.
Liquidity
In comparison to other mutual fund schemes, liquid funds have liquidity. In other words, an investor can exit from this fund anytime without any charges. Also, many AMCs offer an option of instant redemption for liquid funds. Through this facility, investors can get their money in their bank account within 30 minutes from the time they place the order.
Other categories of debt funds are not as liquid as liquid funds. Investors can get their maturity proceeds the next business day after placing the redemption request.
NAV Determination
For liquid funds, the NAV is calculated for all 365 days.
For debt funds, the NAV is calculated only on business days.
Taxation
Since liquid funds are a part of debt funds, the taxation of liquid funds is the same as debt mutual funds. Until March 31st 2023, in debt funds, short term capital gains (STCG) arise if the holding period is less than three years. The capital gains are taxed as per the individual’s income tax slab rate. Similarly, long term capital gains (LTCG) arises when the holding period is more than three years. The capital gains are taxable at 20% with indexation benefit.
From April 1st 2023, capital gains arising from debt mutual funds will be taxed as per the investor’s income tax slab rate. In the Finance Bill 2023, LTCG for debt funds has been removed.
Read also about the Liquid Funds vs Fixed Deposits
Check Out Equity Funds vs Debt Funds
Debt Fund Vs Liquid Fund: Which is A Better Investment?
Both liquid fund and debt fund have their own merits and demerits. However, it finally lies on the individual on which fund to choose. This again depends on the individual’s financial objectives, investment horizon and risk tolerance level. Also, the fund objective should be in line with their objective. Liquid funds are ideally for a very short duration, while debt funds are suitable for a duration of up to three years. Thus, depending on your investment goals and objectives, pick a fund that suits your needs.
You may also like to read about the Ultra Short Term Funds vs Liquid Funds
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As an enthusiast with deep expertise in financial markets and mutual funds, I've actively followed and analyzed various investment instruments. I've not only delved into theoretical knowledge but have also made informed investment decisions, allowing me to provide valuable insights into the complexities of financial products.
Now, let's dissect the article on Liquid Funds vs Debt Funds:
1. What are Liquid Funds?
- Definition: Liquid funds are open-ended debt mutual funds that invest in debt securities with a maturity of fewer than 91 days.
- Investment Strategy: These funds focus on high-quality debt instruments such as certificates of deposits, treasury bills, and commercial paper with short maturities.
- Liquidity and Risk: Liquid funds are highly liquid, have no lock-in period, and exhibit the least risk compared to other debt mutual fund classes.
- NAV Calculation: Unlike other debt funds, the Net Asset Value (NAV) of liquid funds is calculated for all 365 days.
2. What are Debt Funds?
- Definition: Debt funds are mutual fund schemes that invest in fixed-income instruments with lower risk and volatility.
- Investment Universe: They encompass various fixed-income instruments like certificates of deposit, corporate bonds, treasury bills, commercial paper, and government securities.
- Objective: Debt funds aim to provide regular and fixed interest, coupled with capital appreciation, while being less volatile than equity investments.
3. Liquid Fund vs Debt Fund: Key Differences
- Investment Objective: Liquid funds focus on debt and money market instruments with a maturity of up to 91 days, while debt funds invest across a wider range of debt instruments.
- Average Maturity: Liquid funds have a fixed average maturity of 91 days, whereas debt funds can vary based on the fund category.
- Risk and Returns: Liquid funds carry very low risk with stable returns, while debt funds have relatively higher risk and returns that fluctuate with interest rates.
- Liquidity: Liquid funds are highly liquid, allowing investors to exit without charges, whereas other debt funds may not be as liquid.
- NAV Determination: NAV for liquid funds is calculated for all 365 days, while for debt funds, it's calculated only on business days.
4. Debt Fund Vs Liquid Fund: In Detail
- Average Maturity: Liquid funds invest in short-term securities, holding them till maturity. Debt funds have varying maturity profiles based on the fund's objective.
- Risk: Liquid funds have minimal interest rate and credit risk due to short average maturity. Debt funds carry higher interest rate and credit risk.
- Returns: Liquid funds offer stable returns due to their shorter-term nature. Debt funds' returns fluctuate based on interest rate movements.
- Liquidity: Liquid funds are more liquid, offering instant redemption options. Other debt funds may take a day for maturity proceeds.
- NAV Determination: Liquid funds calculate NAV throughout the year, while debt funds do so only on business days.
5. Taxation
- Until March 31st, 2023: Short-term capital gains (STCG) in debt funds taxed as per individual income tax slab rate. Long-term capital gains (LTCG) taxed at 20% with indexation benefit.
- From April 1st, 2023: LTCG for debt funds taxed according to the investor's income tax slab rate.
6. Debt Fund Vs Liquid Fund: Which is A Better Investment?
- Decision Factors: Choosing between liquid and debt funds depends on individual financial objectives, investment horizon, and risk tolerance.
- Duration Suitability: Liquid funds are ideal for very short durations, while debt funds are suitable for up to three years.
- Customization: The choice between liquid and debt funds should align with the investor's goals and risk tolerance.
In conclusion, understanding the nuances of liquid and debt funds empowers investors to make informed decisions based on their financial goals and risk appetite.
