Overnight Funds

Table of Content

1.How Do Overnight Funds Work?

2. Benefits of Overnight Funds

3. Risks Associated with Overnight Funds

4.Taxation of Overnight Funds

5.Who Should Invest in Overnight Funds?

6. How to Invest in Overnight Funds?

7. Conclusion

8. Frequently Asked Questions

Overnight mutual funds are open-ended debt funds that invest in assets with potentially lower risk and a maturity of just 1 day. The underlying securities of such funds are usually government securities, reverse repos, treasury bills and generally include overnight money market instruments.

Its main distinctive feature is its potential immunity to interest rate or inflation-related risks compared to traditional debt funds, making it attractive to investors seeking a safe place to park their money. Another feature of such a fund is that its expense ratio is lower, and typically stays under 1%. Also, these do not charge an exit load, saving on expenses.

However, due to its conservative risk profile, an overnight fund typically generates lower returns than other mutual funds.

How Do Overnight Funds Work?

Overnight funds work by investing pooled investor money into overnight securities that mature within one day. As these underlying securities mature, the respective fund managers use the proceeds from matured debt instruments. Fund managers use them to buy new securities for the portfolio. These new securities also mature on the next business day.

Furthermore, as the maturity period is too short, the fluctuation in its Net Asset value or NAV is also lower. Therefore, the NAV of such funds generally remain stable.

Its daily renewal process ensures that the interest rate risk remains minimal, as it does not invest in long-term securities. It invests in short-term debt instruments with a higher credit rating. Such funds focus on high-quality instruments such as tri-party repos (TREPs) and other securities collateralised by assets other than T-bills and government securities.

Benefits of Overnight Funds

If you are wondering why an overnight fund can be beneficial for a short-term investment? For this, take a look at some key benefits that investors usually enjoy by investing in them:

1. Quick Access to Funds

As you invest in overnight funds, one key benefit is their high liquidity. You can redeem your fund units on any given business day without lock-in restrictions. Its liquidity makes it suitable for cash management, especially when investors need temporary parking for surplus funds. While at the same time, they keep money easily accessible.

2. Ideal for Conservative Investors

You have already noted that these types of funds invest in high-quality, low-risk and short-term securities. Such features typically ensure that the value of your investment in them does not exhibit significant volatility. Here, an investor typically fetches profit primarily from interest income. Hence, it helps with capital preservation while keeping risks minimal.

3. Steady and Low-Risk Returns

Being a kind of debt-oriented mutual fund, an overnight fund is typically considered one of the safest. Apart from eliminating interest and inflation risks, it also reduces the risk of default on interest payments. Therefore, especially if you are a conservative investor, you can achieve a steady, lower-risk return by investing in such funds.

Risks Associated with Overnight Funds

Now that you have noted what is an overnight fund and some potential benefits of investing in them, you must note their drawbacks. Understanding its limitations helps with a better investment decision:

1. Lower-than-Expected Returns

While mutual fund schemes like equity funds involve greater risk, they generally offer higher returns. Traditional debt funds may yield lower returns than equity funds. However, as overnight funds generally take on much lower risks than these two, the potential return also may be lower.

2. Impact of Rising Interest Rates

Any change in the prevailing interest rate may slightly influence returns from such a fund. Suppose there is a sudden increase in the market interest rate. Here, an overnight fund may yield a slightly lower return until it begins investing in new securities at an adjusted interest rate. However, due to its short tenure, such an impact is minimal.

3. Not Suitable for Long-Term Investments

Aside from focusing on safer investment instruments and higher liquidity, such funds typically prioritise capital preservation. If you are an investor looking for long-term growth from a mutual fund, such a fund may not be suitable for you.

Taxation of Overnight Funds

Before you invest your surplus cash in an overnight fund, it is imperative that you understand how it is taxed. As you noted, such funds are kind of debt oriented mutual funds, their taxation is governed by the provisions applicable to specified mutual funds.

For units acquired on or after 01 April 2023, any gains arising on redemption are deemed to be Short-Term Capital Gains (STCG), irrespective of the holding period. Accordingly, such gains are taxable at the investor's applicable income tax slab rates under Section 76 of the Income Tax Act, 2025¹. Also, indexation benefits are not available after that aforementioned date, as the cost of acquisition is considered at actuals.

Who Should Invest in Overnight Funds?

Fund houses typically design mutual fund schemes to address the investment needs of potential investors. Here is a list highlighting suitable investors for this fund type:

• Investors With Surplus Cash: Entrepreneurs or businessmen look for avenues to park their surplus cash for a shorter period before using it elsewhere. Therefore, instead of placing money into current accounts, such funds may generate a decent return in the short term. Regular individuals with surplus cash may also opt for this.

• Surplus Cash Without an Immediate Use: If you have surplus cash with no immediate use, parking it in a savings account may yield a lower return. Therefore, investing such an amount in these funds may yield a better return.

• Comfortable With Lower Return: If you are looking for a safe place to generate a short-term return, you may opt for this. However, you should note that such funds typically yield lower returns than equity and debt funds.

How to Invest in Overnight Funds?

Aside from understanding the specifics of such a fund, you must learn how to invest in it to get started. Here is a step-by-step guide you may follow:

Step 1: Look for overnight mutual fund schemes in the market and compare them based on historical annualised returns, prevailing NAVs, expense ratios, etc. Choose the one which fits your budget and your overall investment goals.

Step 2: Once you select your fund, you can create an account directly with that fund house. You may also choose to create an account with online investment platforms.

Step 3: You may need to fulfil your KYC. To complete your account creation, provide your Aadhaar Card or PAN card.

Step 4: Choose whether you want to invest via Systematic Investment Plan (SIP) or using a lump sum amount. Choose your payment frequency, such as daily, monthly or quarterly, if you opt for an SIP.

Step 5: Place your purchase order online using a payment method supported by your chosen platform. Upon that payment, you will receive your fund units in your account.

Conclusion

Life insurance solutions like Unit Linked Insurance Plans (ULIPs) not only provide financial protection but also allow investments across different fund types, including low-risk debt options suitable for short-term liquidity needs.

Overnight funds are debt mutual funds which invest in securities such as T-bills, government securities, reverse repos and more. However, compared to traditional debt funds, these underlying securities have shorter maturities. Thus, investors looking to park their surplus cash for a short term may find it effective for generating a decent return.

Frequently Asked Questions

1. What is the overnight fund?

An overnight fund is a mutual fund that invests in high-quality debt instruments that mature overnight. Due to its short maturity, it typically avoids inflation, interest, and credit risks.

2. When to withdraw overnight funds?

You can withdraw your investments in such funds to meet financial emergencies or if you have reached your investment goal. Being highly liquid, these funds allow you to redeem units on any given business day.

3. Why invest in overnight funds?

Instead of parking your surplus cash in a current or savings account with a lower interest rate, an overnight fund investment allows you to earn a higher return in a shorter term.

4. How long should I stay invested in Overnight Mutual Funds?

Depending on its short-term nature, your investment horizon should be shorter. Generally, such funds are suitable for investment horizons of a few days to a few weeks.

5. How are overnight funds taxed in India?

Such funds are a kind of debt oriented mutual fund. Therefore, gains you make follow the same tax treatment as a debt fund. Here, you pay a short term capital gain tax for your gains as per your applicable tax slab rate, regardless of your holding period with no indexation benefits under Section 76 of the Income Tax Act, 2025¹.