Liquid Fund vs Debt Fund: Key Differences

Investing money is not always about generating returns; sometimes it is about balancing your portfolio and providing stability in it with some moderate growth. For such investors, liquid funds and debt funds are suitable options.

In today’s blog post, we will give you an overview of liquid funds and debt funds, along with the key differences between them and which one is suitable for you.

What is a Liquid Fund?

A liquid fund is a category of debt-oriented mutual fund in which the fund manager primarily invests the pooled money in short-term money market instruments such as treasury bills, commercial papers, etc., having a maturity of up to 91 days. This category of mutual fund carries low risk because of short-term maturity, and is considered one of the safest funds to invest in. Liquid funds are considered an alternative to your savings account. It offers slightly better returns than a savings bank account and offers high liquidity.

Best 5 Funds to Invest in a Liquid Fund

The best 5 liquid funds in which an investor can invest are as follows:

Funds	1 Year Return	3 Years Return	5 Years Returns	AUM (Crores)
Aditya Birla Sunlife Liquid Fund	6.56%	7.19%	6.16%	45397
Axis Liquid Fund	6.26%	6.95%	6.05%	30166
Bank of India Liquid Fund	6.26%	6.98%	6.06%	1547
Edelweiss Liquid Fund	6.26%	6.89%	5.94%	8875
DSP Liquidity Fund	6.24%	6.92%	6%	16862

Key Features of Liquid Fund

The key features of liquid funds are as follows:

1. Liquidity: Liquid mutual funds offer liquidity to an investor. You can withdraw the money within 24 hours. And certain funds offer instant withdrawals up to a certain limit.
2. No Lock-in: The liquid funds fall under the open-ended category of mutual funds. Hence, one can easily invest and withdraw their funds anytime.
3. Low Risk: As liquid funds invest in short-term securities, they are less sensitive to interest rate changes and carry low risk.
4. Stable Returns: The returns of liquid funds are relatively stable, hence they are suitable for parking short-term money.

What are Debt Funds?

Debt funds are a category of mutual funds that primarily invest money in fixed-income securities such as government bonds, corporate bonds, treasury bills, etc. They can invest in securities having short-term, medium-term and long-term maturity. There are various sub-categories of debt funds, such as short-duration funds, corporate bond funds, etc. Each debt fund carries a different kind of risk, such as interest rate risk, credit risk, etc. Debt funds are generally suitable for conservative and moderate investors who prefer to have stability in their portfolio.

Best 5 Funds to Invest in Debt Funds

The 5 best funds in which an investor can invest are as follows:

Funds	1 Year Return	3 Years Return	5 Years Returns
Funds	1 Year Return	3 Years Return	5 Years Returns	AUM (Crores)
Bank of India Credit Risk Fund	16.91%	9.56%	27.66%	100
Aditya Birla Credit Risk Fund	11.83%	11.81%	9.74%	1178
DSP Credit Risk Fund	9.53%	15.51%	11.95%	223
Nippon India Credit Risk Fund	7.15%	8.02%	8.33%	1058
Aditya Birla Medium Term Fund	7.86%	9.52%	11.78%	3078

Key Features of Debt Fund

The key features of debt funds are as follows

1. Different investment options: Debt fund offers different investment options depending upon the investment objective and risk profile of the investor.
2. Professional Fund Management: In Debt funds offered by the asset management company, the fund is managed by a professional fund manager, and they actively manage the portfolio to enhance returns.
3. Risk Profile: The debt fund is suitable for investors with a conservative and moderate risk profile.
4. Returns: The longer the investment horizon, the higher the returns will be, as the underlying fixed income securities have a higher rate of interest. 

Read Also: Difference Between Large Cap vs Mid Cap Mutual Fund

Difference Between Liquid Fund and Debt Fund

The key difference between a liquid fund and a debt fund is as follows:

Particular	Liquid Fund	Debt Fund
Investment Duration	Investment in a liquid fund is suitable for up to 91 days.	Debt funds are suitable for short, medium and long duration.
Volatile	Liquid funds show almost nil volatility.	Debt funds of longer duration are highly volatile in nature; they can fluctuate due to changes in interest rates.
Suitability	Liquid funds are suitable for investors who want to park their money for a shorter period of time.	Debt funds are suitable for conservative and moderate investors who prefer income generation and wealth preservation over growth.
Returns	Liquid fund offers low returns.	A long-duration debt fund offers higher returns than a liquid fund.
Credit Risk	A liquid fund generally carries very low credit risk.	Debt funds with longer duration carry credit risk.
Portfolio	Liquid funds have Treasury Bills, Commercial Papers, and Certificates of Deposit in their portfolio.	While Debt Funds have bonds, government securities, corporate debt, etc. in their portfolio.

Taxation of Liquid Fund and Debt Fund

Taxation is a key factor which an investor should consider before investing in any debt fund, including a liquid fund. As a liquid fund is a part of a debt fund, both have similar taxation.

Based on the latest Income Tax rules, income from debt funds, including liquid fund are taxed based on the investor’s income slab, irrespective of their holding period. Earlier investors were offered indexation benefit, but later it was abolished by the Ministry of Finance. Therefore, if you fall in a higher tax bracket, then your post-tax return may be reduced.

Debt Fund vs Liquid Fund: Which one is better for you?

Debt funds and liquid funds both serve different objectives but have similar features, such as taxation. Choosing between debt and a liquid fund depends on the investor’s risk profile and investment objective. One can choose a liquid fund if they want to park their money for a few days to months, and are building an emergency corpus. On the other hand, debt funds are suitable if you have a longer investment horizon and are looking for better returns than a liquid fund, with some moderate fluctuations, as debt funds with a longer horizon are volatile in nature.

Conclusion

On a concluding note, both liquid fund and debt fund are suitable for a conservative and moderate investor who does not wish to see volatility in their portfolio and is looking for capital preservation along with limited returns. Both of these funds play a key role in balancing the portfolio. Liquid funds are suitable for parking funds for a shorter duration, while debt funds are for generating a steady income. However, debt funds carry certain risks such as credit risk, interest rate risk, etc. Therefore, it is advisable to consult your investment advisor before making any investment in either a liquid or a debt fund. Invest smarter in mutual funds with Pocketful – zero brokerage, simple interface, powerful tools. 

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