Everyone needs to plan their investments strategically and make sure they are contributing to their overall financial well-being. For many investors, debt investments have an important role in a sound financial portfolio. However, they often get confused between debt and liquid funds. While these two funds generally fall into the same type of asset class and offer liquidity to investors, there are some key differences between them.
Keep reading to know the key distinctions between debt and liquid mutual funds and get insight into which type of investment fits your individual needs and goals.
What is a debt fund?
Debt funds are mutual funds that invest in fixed income instruments such as corporate debt securities, corporate and government bonds, money market instruments, etc. These investments usually generate regular income for investors in the form of interest payments.
Debt funds are often used by investors who want to diversify their mutual fund portfolio and achieve long-term capital appreciation without taking too much risk. However, debt funds are subject to credit and interest risks.
What is a liquid fund?
Liquid funds are a type of debt fund that invest predominantly in highly liquid debt securities of very short tenure (up to 91 days). These can include commercial paper, government securities, treasury bills, etc., and are designed for investors who want access to their money quickly without sacrificing returns or taking too much risk.
Liquid fund vs debt fund – Major differences to consider
- Maturity profile of underlying assets
Liquid funds invest in fixed-income securities with a maturity period of 91 days, meaning the principal and interest payments are returned to investors when the investments reach their maturity date. Meanwhile, debt funds do not have a set/fixed maturity period – the average term of investments will depend on what type of fund it is. For example, you can choose from overnight debt funds with an investment horizon as short as 1 day to gilt funds with a duration of 10 years.
- Liquid and debt fund returns
Liquid funds are typically seen as low-risk investments due to the fact that their instruments mature so quickly and therefore, there is less chance of interest rate fluctuations impacting the fund’s value. Debt funds, however, are a slightly more complex asset class, and they can offer capital appreciation by investing in different types of debt funds and money market securities with varying durations and maturities.
They can potentially offer higher returns over the long term since the markets can change drastically in days or weeks; it’s more likely to fluctuate significantly over a period of one to ten years. So, you can choose from short-, medium-, and long-term debt funds accordingly as per your risk tolerance and investment objectives.
Liquid fund investments offer a very high degree of liquidity, with some asset management companies even offering an instant redemption facility and enabling same-day transfers into your bank account. Compared to this, debt funds tend to have lower levels of liquidity. While you may be able to redeem your funds the next working day after making a withdrawal request, it still does not match the immediate liquidity associated with liquid funds.
Debt funds and liquid funds are two important mutual funds investment options available to investors. While debt fund investment can be used to fulfil both short and long-term goals, liquid funds are ideal for those who need more flexibility or who plan to use these funds as a medium for investing in equity funds later.
Their major similarity is that they both provide investors with opportunities to park their money and earn returns. However, investing in either type of fund requires careful consideration of your financial goals, time horizon, and risk appetite.