Liquid funds are short-term debt funds which can be used as an alternative to a bank savings account. Savings accounts typically give a 4%-6% interest depending on the bank in which you hold a savings account whereas liquid funds give a return of 6-8%.
There is no exit load charged at the time of redemption irrespective of your investment holding period in a liquid fund and post redemption the funds are available to the investor within 24-48 hours.
In case an investor wants to invest systematically in an equity fund, liquid funds can be used to park funds temporarily and then transfer to an equity fund via a Systematic Transfer Plan. A liquid fund helps to generate higher interest than a savings account while the STP helps protect the investor against market volatility.
A liquid fund invests in treasury bills, money market instruments, commercial paper and certificate of deposits for up to 91 days. These holdings are high-quality papers with the shortest maturity period and hence the least risky fund.
Taxation on liquid funds is per a debt fund. When gains are realized within 3 years of an investment, they are taxed per the investor’s tax slab and after 3 years, the gains are treated as long-term capital gains and are taxed at 20% with benefits of cost indexation.
As such if an investor expects to have idle funds in her bank account, it would be advisable to park them in a liquid fund till either an attractive investment opportunity emerges or the funds need to be put to other use. It would be advisable to consult your independent financial advisor to seek the best course of action