Overnight Mutual funds are debt funds and are said to be the safest among debt mutual funds. As debt funds are one of the favorite investment options of risk-averse investors, it is important to learn all about this mutual fund to see whether it would be a good fit for your investment portfolio.
In this article, we will learn what overnight funds are, how they work, who is it suitable for, their benefits, and what should one consider before investing in them.
What Are Overnight Funds?
Overnight funds are open-ended debt funds that invest in overnight securities or assets with a residual maturity of one day. This is a new category of debt funds that was introduced as part of SEBI’s mutual fund reclassification exercise in 2018.
How Do Overnight Funds Work?
Overnight funds are debt funds that lend to corporates for 1 business day. The corporates eligible for borrowing via this route are regulated and are mostly banks, insurance companies, mutual funds, provident funds, and NBFCs (Non-Banking Financial Companies).
At the start of each business day, the Asset Under Management (AUM) is held in cash, later, the fund manager invests in overnight bonds that mature on the next business day.
Fund managers tend to use the cash amount to purchase more bonds overnight, and the cycle continues.
The cut-off timing for applicability of Net Asset Value (NAV) with respect to the purchase of units in Overnight Fund is 12.30 PM. With respect to the redemption of Overnight Funds, SEBI has revised the timings to 1 PM.
Who Should Invest In Overnight Funds?
Overnight mutual funds are suitable for risk-averse investors who want to invest their money in a fund but want to stay invested only for a short time. You can consider investing in overnight mutual funds under the following situations:
For Very Short Investment Horizon – Overnight mutual funds are best suited for those with an investment horizon of one week or less as investors can redeem these securities after holding the units even for a day. This makes overnight mutual funds a better option over liquid mutual funds, which now charge an exit load for redemptions made within a week.
For Routing Investing In Equity Funds – Overnight mutual funds are also suitable for those investors who do not want to take any risks until they wish to invest in equity mutual funds. Later, an investor can use a Systematic Transfer Plan (STP) to route their investments into an equity fund. This makes sure that you can successfully invest in equity mutual funds over time while also ensuring that the corpus is successfully held in an overnight mutual fund.
What Are The Advantages Of Overnight Funds?
Overnight mutual funds offer several benefits to conservative investors or to those who prefer to keep their money in bank savings accounts.
Safer Than Other Debt Mutual Funds
Overnight funds are the safest among debt funds, as they carry zero interest rate risk and come with minimal credit risk. But how does that work? Since overnight funds invest in overnight securities only, there is no chance of making capital gains or losses.
The value of the fund does not show volatility but rises slowly due to interest income. Overnight funds have near-zero credit risk as well because it is highly unlikely for securities maturing in one day to default on interest payments. Hence, overnight mutual funds are relatively safer than other debt mutual funds.
High Liquidity
Overnight funds generally do not have any entry or exit loads, making them highly liquid. This means that investors can withdraw their investments from overnight funds any time they want without compromising the principal invested.
Low Risk
Overnight funds carry low risks, making them a perfect investment option for investors with low-risk appetites.
Best Place To Park Idle Cash
Overnight funds serve as a valuable investment option for investors who want to park their idle cash in a safe place and earn stable returns on them. Unlike most traditional savings options with long investment horizons, overnight funds allow investors to earn gains in a shorter time.
Low Cost
Overnight mutual funds are low-cost debt mutual funds, primarily because their debt holdings are passively managed.
What Are The Factors You Should Consider Before Investing In Overnight Funds?
As mentioned above, overnight mutual funds are the safest funds within the debt mutual fund category. However, there are a few things investors should consider before investing in overnight mutual funds.
Lower Returns
Overnight funds are not designed to offer higher returns. They are similar to a savings account, as your investment in overnight funds will be safe and can be readily withdrawn. Hence, overnight funds tend to provide relatively low returns.
Expense Ratio
Investors must understand the costs involved in investing in mid-cap mutual funds. The expense ratio is the amount charged by fund houses for managing the fund. If a fund has a lower expense ratio, you will earn higher returns. So, it is important to choose a fund that has the lowest expense ratio.
What Is The Taxation On Overnight Funds?
Overnight mutual funds are taxed similarly to debt mutual funds.
Short-Term Capital Gains
If you stay invested in an overnight mutual fund for up to 3 years, capital gains earned are considered short-term capital gains (STCG). The STCG gains are added to the net income tax return of the investor and are taxed according to their tax slab.
Long-Term Capital Gains
If you sell the units of overnight funds after holding them for longer than 3 years, it is considered long-term capital gains (LTCG). LTCG gains are taxed at 20% (plus surcharge as applicable plus 4% Health & education cess) with the benefit of indexation. Indexation allows investors to inflate the purchase price using the cost inflation index.
In The End…
Overnight mutual funds are a great investment option for those who are looking to invest their money in a low-risk investment instrument, park their surplus funds to earn stable returns, and invest in them to lower the risk in their investment portfolio.
If you wish to invest in Overnight Mutual Funds, you can create a free account with Koshex to start your investment journey. With your Koshex account, you can track your net worth, save smartly, and invest in personalized recommendations.
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