Understanding The Difference Between Debt Funds And Liquid Funds: The past few years have shown the world that times are quite different and uncertain.

This has led everyone to invest carefully for the future, seeking safer and more stable forms of investments. In this blog, we’re going to talk about debt funds and liquid funds, stating the difference between the two.

Before we get into the article, let’s understand what are debt funds and liquid funds.

What Are Debt Funds?

Say you’re an investor who wants to invest in securities but you don’t want to take too big of a risk. For conservative investors who want to be involved in the market, but with lower exposure to risk, we have debt funds.

A debt fund is a type of mutual fund that invests in securities with fixed returns. These could be government bonds, corporate bonds, and other fixed-income securities. 

These types of funds are ideal for investors who are risk-averse and want to receive fixed-interest income. Bonds do not fluctuate in the same way as equity funds.

According to the Securities and Exchange Board Of India (SEBI), debt funds are divided into 16 different categories based on different categories. 

See the Full Table Of Debt Funds Below (As Per AMFII)

S. No.Fund NameFund Feature
1Overnight FundOvernight securities having a maturity of 1 day
2Liquid FundDebt and money market securities with maturity of upto 91 days only
3Ultra Short Duration FundDebt & Money Market instruments with Macaulay duration of the portfolio between 3 months – 6 months
4Low Duration FundInvestment in Debt & Money Market instruments with Macaulay duration portfolio between 6 months- 12 months
5Money Market FundInvestment in Money Market instruments having a maturity of upto 1 Year
6Short Duration FundInvestment in Debt & Money Market instruments with Macaulay duration of the portfolio between 1 year – 3 years
7Medium Duration FundInvestment in Debt & Money Market instruments with Macaulay duration of portfolio between 3 years – 4 years
8Medium to Long Duration FundInvestment in Debt & Money Market instruments with Macaulay duration of the portfolio between 4 – 7 years
9Long Duration FundInvestment in Debt & Money Market Instruments with Macaulay duration of the portfolio greater than 7 years
10Dynamic BondInvestment across duration
11Corporate Bond FundMinimum 80% investment in corporate bonds only in AA+ and above rated corporate bonds
12Credit Risk FundMinimum 65% investment in corporate bonds, only in AA and below-rated corporate bonds
13Banking and PSU FundMinimum 80% in Debt instruments of banks, Public Sector Undertakings, Public Financial Institutions, and Municipal Bonds
14Gilt FundMinimum 80% in G-secs, across the maturity
15Gilt Fund with a 10-year constant durationMinimum 80% in G-secs, such that the Macaulay duration of the portfolio is equal to 10 years
16Floater FundMinimum 65% in floating rate instruments (including fixed rate instruments converted to floating rate exposures using swaps/ derivatives)

What Are Liquid Funds?

A liquid fund is a type of mutual fund that comes under the debt fund category. Liquid funds allow you to invest in debt-based securities with quick maturity of 91 days or lower.

These funds are highly liquid and also provide assured returns to investors in the short term. They are made for investors who don’t want to commit long-term to an asset.

Another unique feature of this fund is that it is open-ended, which means that it can be bought and sold anytime. NAV for this type of fund is calculated at the end of the day, based on the security. 

Difference Between Debt Funds And Liquid Funds

Here are the main differences between the two funds. Keep reading to find out!

1. Investment Period

One of the better-known differences between debt and liquid funds is the investment period. While liquid funds have a short maturity period of 91 days, debt funds have a varying duration.

They can either be short-term, mid-term, or long-term funds depending on the investor’s choice.

2. Risk

With every mutual fund advertisement, we might have come across one constant saying, “Mutual funds are subject to market risk”. This applies to every type of fund, including debt funds and mutual funds.

Liquid funds are short-term and so extreme volatility such as market crashes could cause losses to investors. On the other hand, debt funds have credit risk and interest rate risk.

3. Liquidity

The basic understanding of liquidity is how quickly an asset can be converted into cash. Liquid funds are open-ended schemes, meaning investors can redeem their holdings anytime.

This makes them highly liquid whereas the same cannot be said for debt funds. 

4. Tax Benefits

Here, debt funds and liquid funds have no differences as tax benefits are the same for both. Dividends earned from debt funds are exempt from taxes.

For funds held over 3 years or 36 months, taxes are applicable based on different rates. The same applies to short-term capital gains (Below 36 months). This depends on the tax bracket of the investor.

5. Stability

Liquid funds are relatively more stable as they are less affected by the interest rate movements of the market. This is due to their shorter duration of 91 days.

Debt funds are directly affected by interest risk and credit risk, especially since their maturity is much longer than liquid funds.

Also Read: Can Mutual Funds Be Transferred? – Rules Vs Reality!

Table Showing The Difference Between Debt Funds And Liquid Funds

S. No.FactorDebt FundsLiquid Funds
1MaturityVaries from 1 day to 10 years depending on the type of debt fundMaximum Maturity Of 91 Days
2LiquidityDebt funds cannot be liquidated until maturity. Also, it will take investors T+2 days to receive the redeemed funds in their respective accounts.Liquid funds are easier to redeem. Investors have very quick redemption options depending upon the AMC.
3SEBI CategoryA debt fund is a mutual fund that invests in debt-based securities such as government bonds.A Liquid fund is just one among 16 categories of debt funds created by SEBI.
4RiskLong-term debt funds have a risk-adjusted rate of return. The markets change drastically in a 1-10 year period. Investors can choose between short, medium, and long-term debt funds to manage risk. High risk due to short maturity. Sharp market falls during the investment period could cause huge losses.

In Closing 

Debt funds and liquid funds are just 2 funds within the mutual fund scheme of investments. There is no metric that defines one fund as being better than the other. It depends on the investors themselves.

This includes their risk appetite, their investment preferences, timeline, goals, and much more. Remember to read all scheme-related documents before putting in your hard-earned money. Happy Investing!

That’s all for the article Difference Between Debt Funds And Liquid Funds, We hope you enjoyed reading it. Happy Investing!

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