Overnight funds and liquid funds are both used to park money for short periods, but they suit slightly different needs. Overnight funds may be more suitable when the money could be required almost immediately, and minimising risk is the main concern. Liquid funds may be considered when the money can remain invested for a little longer and the investor is willing to accept marginally higher risk for the possibility of better returns. This article explains how the two categories differ and where each one may fit.
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What are liquid funds?
Liquid mutual funds are a type of debt fund that primarily invests in highly liquid and relatively low-risk instruments, such as treasury bills, certificates of deposits, commercial papers, and other short-term debt securities. These funds have a short maturity period, usually ranging from a few days to a few months, with a maximum maturity of up to 91 days. Liquid funds aim to provide investors with easy access to their funds while generating reasonable returns.
Liquid funds can prove to be an attractive option for parking surplus funds.
You can consider investing in Bajaj Finserv Liquid Fund managed by Bajaj Asset Management Limited. The objective of this fund is to provide a level of income consistent with the objectives of preservation of capital, lower risk, and high liquidity through investments made primarily in the money market and debt securities with maturity of up to 91 days only. There is no assurance that the investment objective of the scheme will be achieved.
What are overnight funds?
Overnight funds are a category of debt mutual funds that invest in very short-term instruments that mature overnight, usually within 1 business day. These include tri-party repo (TREPS), government repo/reverse repo (in government securities) treasury bills, and other overnight money market instruments.
Overnight funds are considered even more conservative than liquid funds due to their focus on very short-term instruments. Similar to liquid funds, overnight funds also offer high liquidity, allowing investors to enter or exit the fund at any time.
The primary objective of overnight funds is to provide investors with reasonable returns commensurate with low risk and high level of liquidity, through investments made primarily in overnight securities having maturity of 1 business day. There is no assurance that the investment objective of the scheme will be achieved. If you are an investor, looking to park idle cash to generate returns over and above your current account, you can consider investing in the Bajaj Finserv Overnight Fund.
Liquid funds vs overnight funds: Which is more suitable?
Neither category is suitable in every situation. The choice mainly depends on how soon the money may be needed and how much risk the investor is comfortable taking.
When to choose overnight funds?
Overnight funds may be considered when:
• Money is needed within a few days: They can be useful for temporarily parking surplus cash while keeping it readily accessible.
• Minimising risk is priority: Since the underlying securities mature in one business day, these funds generally carry very low interest-rate and credit risk. However, they are not risk-free.
• The holding period is uncertain: They may suit investors who do not know exactly when the money will be required.
When to choose liquid funds?
Liquid funds may be considered when:
• The money can remain invested for a few weeks or months: They may suit near-term needs such as an upcoming payment or planned expense.
• You seek slightly better return potential: Liquid funds can invest in instruments with maturities of up to 91 days. This may offer better return potential than overnight funds, but it also brings relatively higher risk.
• You want to park surplus money for a short period: They may be used for money that is not immediately required but should remain relatively easy to access.
In short, overnight funds may be more suitable for extremely short or uncertain holding periods, while liquid funds may be considered when the money can stay invested for slightly longer. In both cases, returns are market-linked and are not guaranteed.
What is the time horizon and minimum investment amount for both funds?
Both liquid and overnight funds are suitable for parking surplus cash or for short-term goals such as building an emergency corpus. Minimum investment amounts can vary based on the asset management company. Some funds may have a minimum investment as low as Rs 100 or Rs. 500, while others may require a higher amount.
What returns to expect from overnight and liquid funds?
Overnight and liquid funds do not offer fixed or guaranteed returns. Their returns depend on short-term interest rates, money market conditions, portfolio yields and fund expenses. Overnight fund returns generally move in line with overnight market rates. Liquid funds invest in securities with maturities of up to 91 days and may offer slightly higher return potential, although with marginally higher risk.
However, they may offer the potential for better returns than savings accounts, making them suitable for parking surplus money over short periods.
Returns on savings accounts are fixed; however, returns on mutual funds are subject to market risks.
Tax implications of overnight and liquid mutual funds
Returns (capital gains) from overnight funds and liquid funds are subject to tax. For investments made after April 1, 2023, all gains are deemed to be short-term capital gains, regardless of the holding period, and taxed as per the investor’s applicable income tax slab.
IDCW (Income Distribution cum Capital Withdrawal) payments (if opted for) are also added to the investor’s annual income and taxed at slab rates.
Strategies for using both overnight funds and liquid funds
It is not always necessary to choose one category over the other. Overnight and liquid funds may serve different purposes within an investor’s portfolio, depending on when the money is likely to be needed. Some ways to use both include:
- Separate immediate and near-term needs: Money that may be required within a few days can be kept in an overnight fund, while money meant for expenses a few weeks or months away may be placed in a liquid fund.
- Build an emergency corpus in layers: A portion can be kept in an overnight fund for immediate access, with the remaining amount in a liquid fund for needs that are less urgent.
- Temporarily park investment money: Money awaiting deployment into another scheme can be held in either category, depending on the expected waiting period.
- Use an STP for gradual investment: A liquid or overnight fund may act as the source scheme for systematically transferring money into another mutual fund. The available facilities, exit load and tax implications should be checked first.
The allocation between the two should reflect the investor’s expected holding period, liquidity needs and risk tolerance.
Risks associated with overnight and liquid funds
Overnight and liquid funds typically carry relatively lower risk compared with longer-duration debt or equity funds, but they are not risk-free. Returns may fluctuate due to changes in interest rates or the credit quality of underlying instruments. Understanding these risks may help investors choose funds suitable for short-term parking of funds.
Conclusion:
In conclusion, both overnight funds and liquid funds can be suitable investment options for individuals looking for short-term investment avenues with high liquidity and relatively low risk. While liquid funds offer slightly higher return potential due to their broader investment horizon, overnight funds focus on extremely short-term and secure instruments, making them the lowest-risk category within debt mutual funds. Investors considering starting a Systematic Investment Plan in a mutual fund can consider using an SIP investment calculator to assist their planning process
FAQs
What are the typical investment durations for overnight funds and liquid funds?
Both funds cater to very short-term goals, ranging from a few days to a few weeks or months. Both offer high liquidity.
Are overnight funds taxable?
Yes, overnight funds are taxable. Under current tax rules, capital gains from overnight funds are generally taxed at the investor’s applicable income tax slab, regardless of the holding period.
*The tax information in this article is based on current laws and is subject to change. Please consult a tax professional or refer to the latest regulations for up-to-date information.
How do I choose overnight funds?
When choosing an overnight fund, consider factors such as the fund’s investment objective, portfolio quality, expense ratio, assets under management, and consistency in managing liquidity. You may also review the fund’s riskometer, Scheme Information Document (SID), and historical portfolio disclosures before making an investment decision.
