Opting for a liquid fund or an ultra short debt fund depends on the excess cash you have, your financial goal and risk tolerance.

Liquid funds are usually suitable if you have idle cash sitting in your bank and want to invest in short-term schemes. These funds often generate higher returns than savings bank accounts. So, you can put your money in these funds rather than in banks.

Ultra short funds are beneficial if you want to park your excess money for up to 6 months through an investment vehicle. You can also use them to meet short-term financial objectives. Moreover, you can use these funds for systematic transfer plans.

If you cannot invest a large amount in equity funds, you can put your money in ultra short funds. Then via STP, a specific amount can be transferred at regular intervals to an equity fund. Thus, you can receive returns on short term fund investment.

Simultaneously, you can use a systematic investment plan in equity funds by investing a small fixed amount regularly, and enjoy rupee cost averaging. Anytime you can use a mutual fund SIP calculator to have an estimate of the returns on your fund-based investments made via SIP.

Besides remembering these tips, you need to understand the differences between liquid and ultra short funds to choose what suits you more. Here's a look.

Liquidity

Liquid funds offer more liquidity than ultra short-term funds. Several fund companies offer instant redemption for liquid funds which allows your money to be credited to your account in 30 minutes. However, in the case of ultra short-term funds, you get the proceeds a day after placing the redemption before the cut-off time.

Average Maturity

The underlying securities of ultra short debt funds have an average maturity of 3-6 months whereas the maturity of liquid fund securities is often less than 91 days.

Risk

Liquid funds have a slightly lower risk than ultra short funds since the underlying securities are usually held till maturity. Often such securities are not traded.

Returns

Ultra short debt funds provide somewhat higher returns than liquid funds as they come with a moderately higher risk and even the underlying securities are held longer. 

Exit Load

Liquid funds usually don't have an exit load. So, you can enter and exit them anytime, and receive complete redemption proceeds at withdrawal. Ultra short debt schemes may or may not come with exit loads. They may have a minimal exit load between a week to 3 months. 

Taxation

Taxation of both the funds is like that of debt mutual funds. If you invest in them for less than 3 years, short-term capital gains apply according to individual tax slab rates. Else if you hold the asset for over 3 years, long-term capital gains are taxable at 20%.

Cut-off Timing

The cut-off time to buy a liquid fund is 1.30 pm. Its redemption cut-off timing is 3 pm. However, the cut-off time to both buy and redeem ultra short-term funds is 3 pm.

Now that you know how a liquid fund differs from an ultra short debt fund, consider investing in the one that works for you better.