Debt Funds vs Liquid Funds: Key Differences Explained

Liquid funds and debt funds might sound similar, but they work quite differently. Debt mutual funds include multiple categories, and liquid funds are one of them. Both debt funds and liquid funds invest in fixed income securities such as government and corporate bonds, Treasury Bills, and commercial paper. The duration for which each type holds these investments, as well as the level of risk faced by an investor, is quite different.

To invest wisely based on your individual financial goals and risk profile, it is important to recognise the differences between the two. In this blog, you’ll get to know the differences between debt funds and liquids funds. 

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What Are Debt Funds?

Debt mutual funds are mutual fund schemes that primarily invest in fixed-income securities such as government bonds, corporate bonds, treasury bills, commercial papers, and other debt instruments. Debt fund returns are influenced by interest rate fluctuations, the credit quality of the underlying fixed income securities, and the ability of the fund manager to navigate changing market conditions.

Debt funds generally offer a variety of investment time horizons, which can range from as little as one month to several years. However, this depends on the specific type of debt fund, as determined by the Securities and Exchange Board of India (SEBI). Debt fund returns are influenced by interest rate fluctuations, the credit quality of underlying fixed income securities, and the ability of a fund manager to navigate changing market environments.

There are several categories of debt mutual fund investments, including overnight funds, liquid funds, ultra-short duration funds, low duration funds, money market funds, short duration funds, medium duration funds, long duration funds, and dynamic bond funds.

What Are Liquid Funds?

Liquid funds are a sub-category of debt funds. As such, they invest only in debt and money market instruments that mature within 91 days of purchase. Liquid funds, therefore, offer high levels of liquidity and very low levels of interest rate risk.

A standard liquid fund typically holds treasury bills, commercial papers, certificates of deposit, and other similar short-term debt securities issued by the government or highly rated corporations. The very short maturity profile results in minimal price fluctuation due to interest rate changes. This provides investors with highly predictable returns, which is why they are comfortable with the net asset value (NAV) of liquid funds over longer time frames.

Liquid funds are an effective way to store excess cash temporarily and serve as an alternative to traditional savings accounts or fixed deposits.

Key Differences Between Debt Funds and Liquid Funds

Liquid funds and debt funds are two contrasting sides of the same coin; they differ based on risk, liquidity, tax impact and maturity. Here are some crucial differences between debt funds and liquids funds you should know about before buying one: