Are you planning to start your investment journey but not sure what your risk appetite is? Or do you want to keep your quarterly bonus somewhere accessible before the next big Goa trip? Well, whatever maybe your financial plan, overnight funds may just be the right investment instrument for you. Why, you ask? This article has answers to all your questions. Read along to explore a new investment avenue perfect for different types of investors.
What are overnight funds?
Overnight funds are a short-term investment tool. SEBI refers to it as open-ended debt funds with a maturity period of one day. This type of fund earns interest on a daily accrual basis. Since the maturity period is brief, overnight funds eliminate default credit risks. Overnight funds are taxed like other debt funds, and the tax on gains is determined according to the investor’s tax slab.
How do overnight funds work?
The fund manager invests your money into overnight funds, such as collateralized borrowing and lending obligations (CBLOs), commercial papers, treasury bills, reverse repos, etc. According to SEBI guidelines, overnight funds can only be used to purchase investment units with a one-day maturity period. The idea is to shield investors from high-risk investment options.
These investment instruments will mature on the next business day, i.e., funds in the portfolio will mature each day. Due to the continuous turnover, the investor’s default risk is reduced. Investing in overnight funds is a continuous process, where the proceeds from the last investment are used to purchase new overnight securities.
Who should invest in overnight funds?
Overnight funds are the least risky type of investment. But who should invest in overnight funds? Overnight funds are not meant for everyone, but they are an excellent way to invest for a few.
- Short-term cash requirement: Overnight funds safeguard you and your principal from market volatility and credit risks. Hence, it is ideal for investors looking to park funds that may be required in the very short-term.
- Investing into equity funds: Large deployments in equity funds pose the risk of entering the market at high valuation. These funds can be used to enter equity funds systematically – reducing the risk of entering at high valuations.
What should you remember before investing in overnight funds?
Since overnight funds are a low-risk investment tool that keeps your capital safe, the returns are also modest. You cannot expect to earn stupendous returns from overnight funds. The brief maturity period not only reduces the credit risk but also lowers the interest rates. Therefore, you must give up higher interest for better investment security.
Overnight funds are used for parking funds that may be liquidated in the near term to protect it from market volatility. They can also be used for parking funds for STPs into equity funds. Investing large lump sums into equity funds may pose a risk of entering the market at very high valuations. Hence, these funds are used for slowly deploying funds into equity funds. They are also used to systematically withdraw the funds from equity funds when you are nearing a financial goal.
Why should you consider investing in overnight funds?
Almost convinced about adding overnight funds to your portfolio? Here are four points explaining the advantages of overnight funds.
- Low-risk investment option: The underlying risk is negligible as overnight funds mature on the next business day. These funds also protect your portfolio from market volatility.
- Easy to liquidate: Since the maturity period is one day, these funds offer instant withdrawals up to 50K per day and a T+1 settlement cycle. There is no lock-in period and you can redeem the units at any time.
- Better return than savings account: Overnight funds indeed offer modest returns. However, if you want to keep your emergency funds or extra cash somewhere and earn a return, overnight funds are a better option than a savings account. You will get more returns with overnight funds than with traditional savings accounts.
The Bottom Line:
Investing can be exciting but risky. Overnight funds are perfect for parking short-term funds and investing systematically into equity funds. We hope this article helps you take the first step towards investing in overnight funds and creating long-term wealth.
-Nischay Avichal
