Difference Between Liquid Funds and Liquid ETFs

Liquid funds and liquid ETFs are both secure and low-risk investments designed to provide liquidity, security, and ease of access to your spare cash. Both financial instruments are best suited for individuals who want short-term investment options for idle cash and the avoidance of unwarranted risk exposure. However, in spite of their shared objectives, the two differ significantly in terms of cost, structure, and most importantly, accessibility. Here, we spell it out for you so you can make the right move for your investment goals-whether it’s an easy-access emergency fund or market-transacted flexibility.

Key Differences Between Liquid Funds and Liquid ETFs

Here are some of the key differences between Liquid Funds and Liquid ETFs:

Why Low-Risk Investments Matter?

With economic uncertainty, many people prefer low-risk options like liquid funds and ETFs to manage short-term cash while keeping their savings safe. These instruments are perfect if you save for big medical bills or build a buffer against surprise costs. Their reliability makes them a conservative investor’s best option, especially when interest rates are unpredictable.

How to Invest in Liquid Funds and ETFs?

Starting your investment journey is easy but the process differs slightly depending on whether you choose a liquid fund or ETF:

• For Liquid Funds: Start by opening an account with a mutual fund company or an investment portal website. Complete your KYC, and you can begin investing from as low as ₹1,000. While choosing a fund, go for those with consistent returns and lower expense ratios.
• For Liquid ETFs: You will need a demat and a trading account. Once established, choose an index linked to a money market ETF and purchase it during stock market hours. Monitor trading volumes so you won’t be in a situation of illiquidity when you sell.
• Money Investments: Use investment platforms to update yourself with returns, NAVs, and performance. Redeem your units of liquid funds or ETFs at your convenience, as needed.

Recommended Read: Top ETFs in India

Types of Liquid Investments

• Overnight Funds: They invest in securities with overnight maturities (one day). They have very little interest rate and credit risk, so they are the most suitable option for individuals who are ready to keep their funds idle for a couple of days for moderate returns.
• Ultra-Short Duration Funds: These invest in securities maturing between three months. They provide a slightly higher return than liquid funds or overnight funds but also at a slightly higher risk. They are suitable for investors who are looking for returns better than savings accounts without long lock-in periods.
• Money Market ETFs: These ETFs follow a money market index and provide diversified exposure to securities like treasury bills and short-term corporate paper. Best suited for investors who are familiar with stock market platforms and are seeking flexibility and transparency in pricing.

Risks to Consider

Here are some factors to consider before choosing between the two investment plans:

• Interest Rate Risk: Liquid assets will experience small declines in NAV when interest rates jump unexpectedly, but are made up by short-term securities. ETFs will also have similar problems and infinitesimal price movements when trading.
• Credit Risk: Certain liquid funds place money in rated corporate notes. While default risk is zero, it’s never zero. ETFs follow indexes, which restricts credit risk exposure.
• Liquidity Risk: Certain liquid ETFs don’t get traded too often, affecting the selling price. Liquid funds, however, generally allow you to withdraw at once at NAV.

Strategies for Liquid Investments

The key to maximising short-term investments is how you allocate and structure them. Here are proven strategies for Indian investors:

• Emergency Savings: Liquid funds are ideal for emergency funds, thanks to their stability and quick redemption. You’ll have access to cash in just one working day.
• Short-Term Parking: Liquid ETFs offer trading flexibility and reasonable returns if you want to park extra funds for a few weeks or months.
• Laddering Your Investments: Try splitting your cash between overnight, liquid, and ultra-short-term funds. This maintains liquidity control but traps the best available returns.
• Tax Efficiency: When you hold liquid funds for over three years, you can utilise long-term capital gains tax with indexation. That may mean higher after-tax returns than from other short-term instruments.

Liquid Funds vs ETFs in Economic Cycles

Whenever the Reserve Bank of India alters interest rates, it directly affects the performance of ETFs and liquid funds. In Feb 2025, the RBI had slashed the repo rate by 25 basis points to 6.25%- its first reduction in nearly five years. This had prompted many Indian investors to invest in liquid funds with a view to gaining from increasing bond prices and potential capital gains. On the other hand, active traders used liquid ETFs to position around short-term price action predicated on this policy shift. Your choice depends on whether you prefer passive yield stability or intraday tradability flexibility.

How to Choose Between Liquid Funds and ETFs?

Confused between the two? Use these measures to choose the best low-risk option for your goals:

• Choose liquid funds if you want immediate access, no demat problems, and an easy way of building an emergency corpus.
• Choose liquid ETFs if you already have a trading account and like the convenience of buying or selling within trading hours.
• Always compare expense ratios and past performance on trusted platforms to ensure you make the most of your money.
• Consider your time horizon-from a few days to a few months-and align your investments accordingly.

Recommended Read: Different Types of ETFs

Conclusion

Both ETFs and liquid funds perform well to address short-term liquidity needs for Indian investors.. Consider your investment time frame, comfort level with trading and desired activity level for working your money. By aligning your choice with your risk tolerance and liquidity needs, you can keep your excess funds secure and still keep them earning.