Liquid funds invest in very short term assets like treasury bills, government securities, repos, certificate of deposits, commercial papers etc. These can invest only in debt securities with residual maturity of up to 91 days.

Fund managers of Liquid Funds typically aim to invest into good credit quality and liquid debt instruments. Furthermore, liquid funds are mandated to hold at least 20% of their portfolio in liquid assets such as cash and cash equivalents, treasury bills, government securities and repo on government securities.

Liquid funds are considered least risky among all the debt funds categories except for the overnight fund. However, low risk does not mean no risk. Like any other debt fund, liquid funds are exposed to three main risks – interest rate risk, credit risk and liquidity risk.

The mandated maturity cap of 91 days, likely to keep the interest rate risk to minimum levels as prices of short term debt instruments generally does not change much with changes in market interest rates. However, credit and liquidity risks depend on the credit quality of debt instruments held by the liquid fund. This can differ vastly across different liquid funds. Liquid funds investing higher proportion of its assets in government securities and AAA rated debt are considered less risky.

Liquid funds are generally suitable for a wide range of investors, including:

• Investors who have short-term investment horizon or are not willing to take much risk in their fixed income allocation.

• Investors who want to temporarily park large sum of money, say from a bonus, property sale, inheritance etc, until they decide how to invest that corpus

• Investors who want to stagger their investment in equity schemes through SIPs can park in liquid funds and opt for systematic transfer plan (STP)

• Investors who want to keep contingency funds or emergency corpus in relatively low risk debt schemes.

Yes, Liquid funds are taxable.

If the investment is held for more than 3 years, it is subjected to long term capital gains which is taxable at 20% with indexation benefit. This means that the purchase price is increased to adjust for inflation (using an index provided by the Government) before calculating the capital gain. This reduces the tax liability significantly for investors in high income tax bracket.

If the investment is redeemed before 3 years period, it is considered as short term capital gain. This is taxed at the income tax slab rate applicable to the investor.

If the money is withdrawn within seven days of investing, liquid funds charge an exit load of 0.0070% to 0.0045% of the redemption amount.