Overnight Funds: A Smart Investment Strategy For Beginners

Overnight funds are a type of mutual fund that invests in short-term debt securities, typically with a maturity of just one day. These funds are open-ended and highly liquid, allowing investors to access their money quickly and easily. The main appeal of overnight funds is their low-risk nature, as the short investment horizon and immediate maturity limit exposure to potential losses. While this makes them a safe investment option, it also means that returns are relatively low compared to other types of funds. Overnight funds are a good choice for investors who want to make short-term gains or those who are risk-averse.

How to invest in overnight funds via intermediaries

Overnight funds are a type of debt mutual fund with a very low credit risk. They are open-ended funds that invest in debt securities, reverse repos, and collateralized borrowing and lending obligations (CBLOs) with one-day (overnight) maturity. While retail investors can invest in overnight funds, they are more commonly used by large institutional investors and corporate houses.

If you're interested in investing in overnight funds, you can do so through a trusted intermediary. Here are the steps you need to follow:

• Choose an intermediary platform: Select a trusted intermediary platform such as Groww, ET Money, or any other reputable platform that offers overnight fund investments.
• Register and complete KYC: Sign up on the chosen intermediary platform and provide the necessary Know Your Customer (KYC) details, such as your PAN number and bank details.
• Choose an overnight fund: Research and select the specific overnight fund you want to invest in. Consider factors such as the fund's performance track record, expense ratio, and returns.
• Decide on the investment amount and mode: Determine how much you want to invest and choose between a lump sum investment or a Systematic Investment Plan (SIP).
• Make the investment: Follow the platform's instructions to complete the investment process and make the payment.

By investing in overnight funds through an intermediary, you can access expert recommendations and a user-friendly interface to facilitate your investment journey. Remember to carefully consider your financial goals, risk tolerance, and investment horizon before investing.

How to invest in overnight funds directly

Overnight funds are a type of mutual fund that is suitable for investors with a very short investment horizon or those who want to invest their money for a short time. These funds are considered safe and liquid, with minimal credit risk and no interest rate risk. Here are the steps to invest in overnight funds directly:

• Know your investor profile: Before investing in overnight funds, it is important to understand your investor profile, including your risk tolerance, investment horizon, financial goals, and investment preferences.
• Choose a fund: Select an overnight fund that aligns with your investment objectives. Compare different funds in the market by analysing their historical performance, expense ratios, and the credibility of the fund manager.
• Register with a platform: You can invest in overnight funds directly through an Asset Management Company (AMC) or an online investment platform. Register with the platform by providing your personal and financial information, such as your name, contact details, bank account details, and PAN number.
• Complete the Know Your Customer (KYC) process: The KYC process is mandatory for investing in mutual funds in India. Submit the required documents, which typically include proof of identity, proof of address, and proof of income.
• Place a purchase order: Log in to your chosen platform and select the overnight fund you wish to invest in. Specify the amount you want to invest and choose between a lump sum investment or a Systematic Investment Plan (SIP). Review the details of your investment and confirm the purchase.
• Monitor your investment: After investing in an overnight fund, it is important to regularly monitor its performance. Track the fund's returns, expenses, and any news or updates related to the fund. Evaluate the performance against your investment goals and make adjustments as necessary.
• Redeem your investment: Overnight funds offer high liquidity, allowing you to redeem your investment quickly. You can choose to redeem your investment at any time, typically through the same platform where you made the initial investment. Follow the redemption process specified by the platform, and ensure you understand any applicable fees, charges, or tax implications.

By following these steps, you can directly invest in overnight funds, providing you with a safe and flexible investment option for your surplus cash.

Understanding the tax implications of overnight funds

Overnight funds are taxed like debt funds. The tax you pay depends on how long you've held the units for and when you made your investment.

Held for less than three years

If you've held the units of an overnight fund for less than three years, your gains are considered short-term capital gains and are taxed according to your income tax slab rate.

Held for more than three years

If you've held the units for more than three years, your gains are considered long-term capital gains and are taxed at a rate of 20%. For investments made before 1 April 2023, you get the benefit of indexation.

Dividend option

If you opt for the dividend option, you need to pay a dividend distribution tax of 29.12%.

Investments made before 1 April 2023

If you invested in overnight funds before 1 April 2023, the tax rules are different.

#### Short-term capital gains

If you redeem your investment within three years, the gain is considered a short-term capital gain and is added to your overall income. It is then taxed according to your income tax slab.

#### Long-term capital gains

If you redeem your investment after three years, the gain is considered a long-term capital gain and is taxed at a rate of 20% with indexation benefits.

Pros and cons of investing in overnight funds

Pros of Investing in Overnight Funds:

• Low Risk: Overnight funds are considered very low-risk investments due to their short investment horizon. The underlying securities have a low default risk, and the funds are not affected by changes in interest rates or credit ratings.
• High Liquidity: These funds are regarded as highly liquid investments, allowing investors easy and quick access to their funds. There are no entry or exit loads, making it convenient for investors to liquefy their investment in an emergency.
• Better Utilisation of Idle Funds: Overnight funds offer investors the ability to use their cash reserves more profitably. They are ideal for those with extra cash who want to generate higher profits at minimum risk.
• Safe Against Market Volatility: The short investment horizon of overnight funds protects investors against risks like interest rate fluctuations, liquidity uncertainty, and credit risk.
• Tax Advantages: Overnight funds offer tax advantages similar to other debt funds. Long-term capital gains (held for more than 3 years) are taxed at a lower rate with indexation benefits.

Cons of Investing in Overnight Funds:

• Modest Returns: While overnight funds offer moderate returns, they are typically lower than those of other debt funds. Investors seeking higher returns may need to consider alternative investment options.
• Interest Rate Sensitivity: Returns on overnight funds can be impacted by changes in interest rates. A decrease in interest rates may lead to lower returns, while an increase may result in a sudden rise in the fund's value.
• Credit Risk: Although rare, overnight funds are not entirely free from credit risk. There is a slight possibility that the issuer of the underlying assets could default on their obligations, resulting in a loss of part of the investment.
• Limited Control: Investors in overnight funds do not have a say in the selection of debt instruments within the fund. The portfolio is solely managed by fund managers, leaving investors with no influence over the investment choices.

How to choose the right overnight fund

Overnight funds are open-ended debt funds that invest in securities with a maturity period of one day. They are ideal for investors who want to park their surplus cash and earn slightly higher returns than a savings account, with very low risk. Here are some key factors to consider when choosing an overnight fund:

• Understand the objective: Overnight funds are designed for short-term investments, typically with a holding period of less than a day. They aim to provide high liquidity and safety by investing in very short-term debt instruments. Ensure that your investment objectives align with this, such as parking surplus cash or managing temporary liquidity needs.
• Check performance: While past performance doesn't guarantee future results, reviewing a fund's historical performance can give you insights into its consistency and reliability. Compare the performance of various overnight funds over different periods to identify those that have consistently delivered returns close to the benchmark.
• Evaluate expense ratios: The expense ratio is the annual fee charged by the fund, expressed as a percentage of the fund's average assets under management. Lower expense ratios can enhance your net returns. Look for funds with competitive expense ratios, but also consider other factors like fund size and management quality.
• Review fund manager expertise: The experience and track record of the fund manager are important. A seasoned fund manager can effectively navigate interest rate fluctuations and credit risks. Research the manager's background and their approach to managing overnight funds.
• Assess credit quality: Overnight funds typically invest in high-quality, short-term debt instruments. Check the fund's credit quality and ensure it adheres to a conservative credit policy to minimize risk.
• Compare liquidity: Since overnight funds are meant to provide liquidity, confirm that the fund maintains high liquidity levels. This ensures you can quickly access your money without significant delays or penalties.

By carefully considering these factors, you can select an overnight fund that aligns with your investment goals, risk tolerance, and liquidity needs.

Frequently asked questions