Liquid Funds vs FD: The Key Differences

Quick Summary:

• Fixed deposits offer fixed returns with no market risk; liquid funds are mutual funds that invest in high-yielding fixed-income securities
• Liquid funds provide quick redemption and slightly higher returns, making them better for short-term goals
• FDs preserve capital, while liquid funds add liquidity; together, they can balance safety and returns
• Pick FDs for stability and certainty; liquid funds for liquidity and short-term needs.

Personal finance offers a wide range of investment options. For risk-averse investors, fixed deposits (FDs) and liquid funds are two common choices. In an FD, you deposit a lump sum for a fixed tenure at a predetermined interest rate. A liquid fund, on the other hand, invests in short-term debt instruments and provides relatively stable returns with easy liquidity.
While both are considered low-risk investments, it is important to understand the difference between FD and liquid funds to make an informed investment decision. 
In this guide, we will analyze the features of both instruments to help you determine which is better suited for your financial goals. Keeping your financial goals, risk appetite, and investment horizon in mind, this guide would also help you determine which investment best fits your portfolio. For a detailed comparison of liquid funds vs FD, let's first take a look at them individually.

What Are Liquid Funds?

Liquid funds, a category of mutual funds, invest in fixed-income securities with short maturities. They pool money from multiple investors and aim to generate short-term returns through a mix of debt instruments. Professional fund managers manage these funds.

Some common examples of fixed income instruments that liquid funds invest in, include:

• Commercial papers
• Treasury bills
• Certificates of deposit
• Short-term government securities
• Money market securities

Liquid funds are considered to be low-risk and are ideal for short-term investments. While they may not boast as high returns as equity mutual funds, they are well-suited for investors who wish to invest their surplus cash for a shorter term. 

Key Features of Liquid Funds:

Let us take a look at the main features of liquid funds.

Lower risk as compared to equity mutual funds

As liquid funds carry a relatively low credit and interest rate risk, they are considered a low-risk investment option compared to other debt funds and equity mutual funds.

Short investment horizon

Liquid funds typically have a short investment period, often as brief as 91 days. With minimal market risks, they can offer a steady income from your investment, ideally for the short term.

High liquidity

Another benefit of liquid funds is the high liquidity that they offer. Usually, there is no lock-in period with liquid funds, and most securities allow for quick redemption within 2 days (T+1 business day).

Low exit load

Unlike other mutual funds, liquid funds do not require active management. They thus come with a low expense ratio and no exit load (after 7 days of holding).

Better returns as compared to current and savings accounts.

The interest rate you receive on the liquid funds is typically higher than that offered in your regular bank current and savings accounts.

What Are Fixed Deposits (FDs)?

Fixed deposits, offered by banks and non-banking financial companies, are one of the most traditional and widely trusted investment products. Despite the popularity of many other high-return options, FDs continue to be a part of most financial portfolios.

In a fixed deposit, you deposit a lump sum amount for a fixed period of time, ranging from a few days to up to 10 years. At the end of the tenure, you receive your principal plus the accumulated interest. The maturity amount is assured, as the rate of return is predetermined. It is ideal for people who wish to choose a risk-free option; FDs are free from market fluctuations. 
Suggested Read: Tax Saving FDs For Short-Term Goals: A Strategic Approach

Key Features of Fixed Deposits:

Listed below are the key features of fixed deposits:

Guaranteed returns

Unlike market-linked instruments, the returns on an FD are fixed and predetermined at the time of investment.

Flexible tenure

FD tenures can range from 7 days to 10 years, giving investors flexibility based on their financial goals.

Risk-free investment

Since FDs are not subject to market fluctuations, they are considered a risk-free investment. FDs are safe investment options; however, when choosing a bank/NBFC, it is crucial to choose a reliable and trusted name.

Did you know that Mahindra Finance fixed deposits are awarded the status of “IND AAA/Stable” by India Ratings? The company also received “CRISIL AAA/Stable” by CRISIL Ratings, which is a clear indication of its trustworthiness.

Premature withdrawals

FDs come with a lock-in period, which is the chosen tenure; however, premature withdrawals are allowed. Please bear in mind that you would have to pay a small charge when you break an FD before its maturity.

Taxation

The interest you earn on an FD comes under the category of Income from Other Sources, and is taxable. Union Budget 2025-26 increased the TDS exemption limit.

• ₹50,000 for regular citizens
• ₹1 lakh for senior citizens.

How Liquid Funds Differ from Fixed Deposits?

Take a look at the table below for a detailed fixed deposit vs liquid fund analysis. 

When to Choose Liquid Funds Over FDs?

Are liquid funds better than FDs? Take a look at when you can opt for liquid funds.

When you have short-term investment goals

Liquid funds are ideal for short-term investment goals, typically lasting 3 months. 

When you prefer higher liquidity

There’s no lock-in period in liquid funds. Without the worry of a penalty, you can easily redeem the funds.

When you want better returns

For a conservative investor seeking better returns, liquid funds may be a more suitable option. However, do keep in mind that liquid funds do come with a certain amount of risk.

When to Opt for Fixed Deposits Instead?

In our discussion of FD vs liquid mutual fund, let us discuss when you can opt for FDs.

When you want stable and guaranteed returns

FDs are known for their simplicity, safety, and guaranteed returns. There’s no guesswork as the returns are not related to the market.

When you are looking for a long-term investment

While FDs come with a lot of tenure options, the ones with a longer tenure typically offer higher rates of return. 

Note: Since FDs can be liquidated online and within minutes, they are usually considered a perfect instrument to keep your emergency corpus, where the money can be withdrawn immediately.

When you have a risk-averse investment strategy

As an investor with a low risk appetite, FDs can help you safely grow your savings.

When you want a tax-saving instrument

FDs can also help you with tax savings. Tax-saving FDs come with a 5-year lock-in period. They allow an exemption of up to ₹1.5 lakhs per year under Section 80C in the Old Tax Regime.

Where Liquid Funds and FDs Fit in an Investment Portfolio?

As discussed, both FDs and liquid funds are safe and low-risk financial products. While they are often preferred by individuals with a low-risk appetite, they are not limited to such investors. Here’s how.

Role of liquid funds in portfolio diversification

Liquid funds work as an effective parking space for short-term funds. Whether you want to build an emergency reserve or have idle cash to invest, liquid funds can be useful. They also provide better liquidity and potential for slightly higher returns than a savings account.

Role of FDs in capital preservation within an investment portfolio

FDs, a long-standing and trusted choice in many Indian households, are ideal for capital preservation. They also provide stable returns, making them a suitable choice to park surplus cash. Conservative investors seeking to avoid the risks of the money market and retirees requiring a stable income can find FDs more well-suited.
Using them together for financial balance.

Fortunately, investors do not have to choose only one; both instruments can be used together effectively. You can keep your emergency fund in liquid funds for easy access without any cost and invest in FDs for long-term savings goals. However, liquid mutual funds require a minimum of T+1 business days to be liquidated, while FDs can be liquidated within minutes. Enjoy the best of both worlds!

Why Understanding Liquid Funds and FDs is Crucial for Investors?

There’s no denying that both liquid funds and fixed deposits offer safety, liquidity, and returns. However, this does not imply that choosing between liquid funds vs FD can be done without assessing your financial goals.

Clearly understanding the product, you choose is crucial, as it can save you from misjudging your financial needs and choosing the wrong investment. Carefully weighing the pros and cons of each will help you correctly align your investments with financial goals and risk tolerance.

Conclusion

The differences between liquid funds and fixed deposits are rather evident. Thus, the debate of FD vs liquid fund cannot have a one-size-fits-all solution. Both are useful and valuable in their own way. What is important is to be clear about your financial goals and risk tolerance. The importance of informed decision-making in maximising gains and achieving financial security cannot be overstated.
Suggested Read: Top Fixed Deposit Investment Mistakes To Avoid

FAQs on Liquid Funds and FD

What is more liquid: a fixed deposit or a liquid fund?

Both fixed deposits and liquid funds offer liquidity. FDs have a lock-in period, but they allow premature withdrawals with a small penalty. Liquid funds have no lock-in and no exit load (typically after 7 days of holding) and allow quick and easy redemption.

Can liquid funds be considered a safe investment?

Compared to equity mutual funds, liquid mutual funds are considered quite safe. They invest primarily in short-term, high-quality money market instruments. However, when compared to FDs, liquid funds can be a little risky.

How are liquid funds taxed compared to fixed deposits?

In FDs, a 10% TDS is applicable on the interest earned, which is taxed as per the exemption limit and income tax slab. For liquid funds, returns are taxed according to the holding period and your tax slab, since the concept of indexation has been abolished.

What are the withdrawal procedures for liquid funds and FDs?

The withdrawal procedures for liquid funds and FDs depend on the bank/ financial institution. Online procedures can make the withdrawals very easy and quick. In most cases, liquid fund redemption is easier and can be processed in 24 hours. For early withdrawals of FD, you need to get in touch with the bank or, if applicable, carry out the process online.

Is it possible to lose money in liquid funds?

Liquid funds are considered to be a rather low-risk investment, as compared to other types of mutual funds. Though rare, losing money in liquid funds is possible as they are subject to market movements.