It is hard to say outright because liquid funds have a lot of good points and a few challenges too. You need to take call based on the relative merits and demerits of these liquid funds vis-à-vis bank deposits.

Key advantages of liquid funds

Liquid funds are generally compared to savings bank accounts but they score over savings accounts because liquid funds offer pre-tax returns that are linked to an underlying portfolio of securities as against a savings bank that pays just around 4%. An average savings account gives returns of 4%, in pre tax terms and 2.8% in post tax terms. However, liquid funds give about 6% in pre tax terms and nearly 4.5% in post tax terms. In fact, you can structure SWPs to reduce the tax and enhance your post tax returns.

Typically, liquid funds also offer instant redemption access facility on withdrawals up to Rs.50,000 and for larger amounts, the redemption is processed on T+1 day. That is as close to a bank account as possible. There is no lock-in period and also no exit load on liquid funds and that makes it ideal for parking short term money.

Liquid funds have the advantage of being more flexible compared to bank accounts. You can structure these liquid funds in the form of systematic withdrawal plans (SWP) and some even offer the facility of checking accounts and week end accounts for idle funds.

But, there are some challenges too

Savings bank accounts are covered under deposit insurance up to Rs.1 lakh per person. No such feature is available with liquid Funds and the entire investment is technically a risk investment.

There is the risk of volatility in the short end as we saw during Lehman crisis and that adds to your risk when you need to exit at short notice. Also some funds, we saw recently, go for lower grade investments.