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Mutual fund investments have become a popular investment option in India. One can invest for both short term and term horizon in mutual funds. For short term investments in mutual funds, investors come across ultra short term funds and liquid funds. Though both the funds are categorized under debt mutual funds, they both have different characteristics. 

Here, in this article, we have covered the differences between ultra short term funds vs liquid funds. 

What is an Ultra Short Term Fund?

Ultra short term funds, sometimes also known as ultra short duration funds. These schemes are open-ended debt mutual funds. The fund’s portfolio invests in securities that have a maturity period between 3-6 months. This fund invests in securities like money market instruments or fixed income securities like treasury bills, commercial papers and certificate of deposits with maturities below six months. 

Moreover, these provide reasonable returns with sufficient liquidity. The securities have low maturities, which makes the fund less sensitive to market movements. Generally, this fund is suitable for those who want to park their excess funds for up to 6 months. Furthermore, these funds also charge a fee to manage the fund. This fee is referred to as the expense ratio. SEBI has levied an upper limit on the expense ratio to be 1.05%. 

What is a Liquid Mutual Fund? 

Liquid funds are open-ended debt mutual funds that invest in debt securities with a maturity of fewer than 91 days. The debt instruments that the fund portfolio invests in are of high credit quality. They invest in money market instruments like certificates of deposits, treasury bills and commercial paper for up to 91 days. Unlike any other debt funds whose NAV is calculated only on business days, liquid funds NAV is calculated for 365 days. Furthermore, these funds also charge a fee for fund management and other expenses. This fee is referred to as the expense ratio. SEBI has levied an upper limit on the expense ratio to be 1.05% for these funds. 

Liquid schemes are highly liquid in nature and have no lock-in period. In other words, there is no entry and exit load while investing in this fund. Moreover, the risk associated is the least in comparison to other classes of debt mutual funds. These schemes can give better returns than savings bank accounts. Therefore, anyone having idle funds lying in their bank account can park them in these funds to earn better returns. 

Differences Between Ultra Short Term Funds Vs Liquid Funds

The following are the key parameters that show the differences between Ultra Short Term Funds vs Liquid Funds. Therefore, one should understand the differences between ultra short term funds vs liquid funds before investing in them.

1. Average Maturity

The average maturity of the underlying securities of ultra short term funds is higher when compared to liquid funds. The securities of liquid funds have a short maturity of fewer than 91 days. However, for ultra short term funds, the underlying securities are held for 3-6 months. 

2. Fund Liquidity

Liquid funds have higher liquidity in comparison to ultra short term funds. In the case of liquid funds, many mutual fund companies provide an option of instant redemption. By opting for instant redemption, the money gets credited into the account within 30 minutes. On the other hand, ultra short term funds do not have this facility. After placing the redemption, the investor will receive the proceeds the next day (T+1). However, the redemption has to be placed before the cut off time. 

3. Returns

The returns of ultra short term funds are slightly higher than the liquid funds. The higher returns are due to the slightly higher risk in these funds as the underlying securities are also held for a longer time, i.e. 3-6 months. 

4. Risk

The risk in the ultra short term is marginally higher than liquid funds. Also, liquid funds have low risk because the underlying securities are mostly held till maturity. Usually, these securities are not traded. 

5. Exit Load

Generally, liquid funds do not have an exit load. An investor can enter and exit the fund anytime. Therefore, investors can get entire redemption proceeds at the time of withdrawal. Conversely, ultra short term funds may or may not have exit loads. These funds have an exit load for a very short period, usually between 1 week to 3 months, which is very minimal. 

6. Cut Off Timing

The cut-off timing for liquid fund purchase is 1.30 pm. However, the redemption cut off timing for liquid funds is 3 pm. Simultaneously, the cut off timing for purchase and redemption of ultra short term funds is 3 pm. 

7. Taxation

Taxation of any of these funds is similar to debt mutual fund taxation. If an investment is made for less than three years, short-term capital gains are calculated based on individual tax slab rates. If the asset is held for more than three years, long-term capital gains are taxed at 20%. 

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Should I Invest in a Liquid or an Ultra Short Duration Funds?

Investing in a liquid fund or an ultra short term fund depends on the short term financial objective of the investor and the excess cash they have with them. Also, one must understand the credit risk and interest rate risk associated with these funds.

Generally, liquid funds are ideal for those having idle cash lying in their bank account and looking to invest in short term instruments. A liquid fund tends to give more returns than a savings bank account. Therefore, instead of parking excess funds in a bank, investors can choose these funds. For instance, if a person receives incentives, bonus, gifts from family, etc. can invest this money in these funds first to gain extra returns. 

Ultra short term funds are suitable for those looking for investment vehicles to park their excess surplus for up to 6 months. These funds can also be used for short term financial goals. Furthermore, they can be used for Systematic Transfer Plans (STPs). Instead of investing a lump sum amount in equity funds, one can invest them in ultra short term funds and use STP to transfer a certain amount of money (daily, monthly or quarterly) to an equity fund. This way, one can earn returns on short term debt fund investment. At the same time, they can take advantage of SIP in equity funds. Also, it gives them the benefit of rupee cost averaging. 

How to Invest?

Mutual fund investments can be made either online or offline. Through offline mode, one has to physically visit the AMC office, fill a form along with a cheque and submit the form. Similarly, the investor can also do it through an agent or distributor. Also, the investor can invest online through an agent or distributor platform. 

One can invest through Scripbox simply and systematically. The investments through Scripbox are entirely online and paperless. Investments in mutual funds can be made through a lump sum or SIP (Systematic Investment Plan) route. The following is the step by step process to invest in ultra short term funds through Scripbox –

  1. Visit the Scripbox website.
  2. To start investing with Scripbox, one has to choose a plan.
  3. The next step is to create an investment account.
  4. After setting up the account, select the mutual fund to invest in and the amount to invest. 
  5. Input the payment details. The payment can be done instantly or set up for a later date. 
  6. Finally, the money gets deducted from the bank account and allotted to the respective mutual fund house. 
  7. The mutual fund company allots units to the investor. The same is confirmed via SMS or email. The same gets updated on the Scripbox account. 

Read also about the Arbitrage Funds Vs Liquid Funds

Frequently Asked Questions

Which is better liquid fund or debt fund?

Many times, people get confused between liquid funds and debt funds. However, both of them are different. A debt fund is a fund category of mutual fund that invests in fixed-income securities. The liquid fund is a sub-category of a debt fund that invests in securities for up to 91 days. 

A liquid fund is suitable for investors who have idle excess cash lying in their bank account. Such investors can park their extra cash in liquid funds that can yield better returns than savings bank accounts. On the contrary, a debt fund has a combination of both short term and long term securities. Thus, the returns of these funds fluctuate as they are sensitive to interest rate movements. Therefore, investors must have a proper understanding of risk before choosing to invest in these funds. 

To sum up, the investor must choose a fund to match their financial needs and objectives. Also, they should check if the fund’s objective matches with their objective. Furthermore, one should understand the scheme in detail before investing in it. 

Which is the best Ultra Short Term Fund?

Ultra short term funds are a type of debt funds that have a horizon of up to 3-6 months. They primarily invest in debt securities that have a maturity of 91 days to 180 days. Investors can choose to invest in these funds based on their investment horizon, financial goals and understanding of risk. The selection of the best fund depends on the investor’s financial needs and objectives. 

Scripbox is an online platform that uses proprietary algorithms to select funds based on a set of different criteria. The Scripbox algorithm recommends 2-4 funds for investments for asset classes such as liquid, ultra short term, etc. Therefore, when the investor chooses a financial objective, the algorithm suggests an appropriate asset class and funds. 

Is it safe to invest in ultra short term funds?

Ultra short term funds are debt funds that invest in securities for up to 6 months. They invest in securities with maturities of 91 days to 180 days. The tenure for these funds is anywhere between 1 month to 6 months. Hence, one can consider these funds for short term investments. Investors with excess funds can park their money for a short term investment horizon. These funds are considered less risky than duration debt securities as they are immune to interest rate movements. With a short term horizon, the interest rate changes wouldn’t be very drastic. Hence these funds can give predictable returns.

What is the difference between Low Duration Fund and Liquid Fund?

Low duration funds are debt funds that invest in debt securities with maturity between 6-12 months. In comparison, liquid funds invest in debt securities for up to 91 days. In contrast to liquid funds, low duration funds hold assets of longer duration and lower credit quality. Therefore, low duration funds have higher interest rate risk and credit risk. Moreover, these funds outperform the liquid funds as they allow them to take on greater credit and duration exposure. 

Low duration funds can be an alternative to fixed deposits as they can enter and exit anytime. Similarly, liquid funds can be an alternative to savings bank accounts where individuals can park their idle money in these funds. These funds can also be used for short term financial goals. Furthermore, they can be used for Systematic Transfer Plans (STPs). Instead of investing a lump sum amount in equity funds, one can invest them in a low duration fund and use STP to transfer a certain amount of money to an equity fund. This way, one can earn returns on debt fund investment.