Overnight Funds Vs Liquid Funds

Overnight funds and liquid funds fall under the category of debt mutual funds. Overnight funds typically allocate their portfolio into securities with a maturity period of just one day, while liquid funds focus on investing in debt and money market instruments that mature within 91 days.

While both have a short-term time horizon, they differ significantly in terms of returns, risk and liquidity. This article will give you a detailed description of overnight funds, liquid funds, and the difference between liquid vs overnight funds.

What are overnight funds?

As the name suggests, overnight funds are open-ended debt funds that mature overnight. These funds work by gathering cash at the opening bell. Then, the fund gets deposited in overnight debt securities, and the capital is recovered the next morning.

Overnight funds do not carry any interest or credit-based risks due to the short time frame. Overnight funds consist of debt securities like bank deposits, overnight reverse repo

collateralised borrowing and lending obligation (CBLO), bill discounting, etc.

Also, as regulated by SEBI, it is mandatory for overnight funds to only invest in debt funds that have low risk. Read more about, What are overnight funds.

What are liquid funds?

Liquid funds are short-term open-ended debt mutual funds that invest in financial instruments that mature in 91 days. Their main aim is to ensure easy access to funds while providing a reasonable return on investment. They are especially used for parking surplus funds in the short term.

While liquid funds have become popular due to their short-term portfolio maturity, they have a higher chance of interest or credit-based risks when compared to overnight funds.

Liquid funds typically invest in instruments like corporate bonds, treasury bills, certificates of deposits, Government securities, and commercial papers. Read more about, What are liquid mutual funds.

Overnight funds Vs Liquid funds - A table comparison

Let’s understand the difference between liquid vs overnight fund:

Difference between overnight funds and liquid funds

Now that you are aware of the basic differences, let’s understand how overnight funds and liquid funds differ on other factors:

1. Net Asset Value fluctuations: Overnight funds undergo minimal–almost negligible fluctuations, while liquid funds undergo minimal but slightly more volatile fluctuations than overnight funds.
2. Suitability: Investors looking for short-term parking of funds with minimal risk opt for overnight funds, such as corporate treasuries and individuals with surplus funds for a short duration.
   Investors looking for short-term parking of funds with slightly better returns than overnight funds go for liquid funds.
3. Interest rate sensitivity: Overnight funds are insensitive to interest rate changes, while liquid funds have low sensitivity to interest rate changes.
4. Exit load: Overnight funds have no exit load, while liquid funds may attract exit load if redeemed within 7 days.
5. Redemption time: Overnight funds typically offer same-day redemption. On the other hand, liquid funds usually provide redemption on the same day or the next business day.
6. Taxation: Both these funds are taxed as per the investor's income tax slab for short-term capital gains.

What returns can an investor expect from overnight funds and liquid funds?

Overnight funds and liquid funds are popular choices for investors seeking short-term investment options with relatively low risk. Typically, these funds offer better returns compared to traditional savings accounts. While savings accounts might offer an interest rate of around 2-5%, overnight and liquid funds can provide returns in the range of 6.5-7%. This substantial difference makes these funds an attractive alternative for parking short-term funds.

Overnight funds invest in securities with a maturity of one day, making them one of the safest mutual fund categories. They are ideal for investors looking to invest their surplus money for a very short period, ranging from one day to a week. The returns, though relatively modest compared to long-term investments, are higher than those from savings accounts, making them a better option for very short-term needs.

Liquid funds, on the other hand, invest in debt and money market securities with a maturity of up to 91 days. These funds are suitable for investors who wish to invest their money for a period ranging from a few days to a few months. They offer slightly higher returns compared to overnight funds due to the longer maturity period of the underlying securities. The liquidity and safety of these funds make them an excellent choice for meeting short-term financial goals like paying school fees, going on a vacation, or saving for a small purchase.

Also read: What Is Compound Annual Growth Rate (CAGR)

What is the time horizon and minimum investment amount?

When considering overnight and liquid funds, it is important to understand the appropriate time horizon and the minimum investment amounts involved. Financial planners suggest that investors should use overnight funds if they have a very short time frame, such as one day to a week. These funds are ideal for extremely short-term parking of funds due to their high liquidity and minimal risk.

Liquid funds, however, are more suited for slightly longer durations, typically from seven days to a few months. These funds are ideal for investors who might need access to their money within a short period but still want to earn a higher return compared to savings accounts. The maturity period of up to 91 days for the securities held by liquid funds allows them to offer better returns while maintaining a low risk profile.

In terms of the minimum investment amount, most mutual fund houses set a very low threshold, making these funds accessible to a wide range of investors. Typically, investors can start with as little as Rs 500 as a lump sum investment in these schemes. This low entry barrier allows even small investors to take advantage of the benefits offered by these funds.

Moreover, liquid funds often come with a graded exit load, which means that the penalty for withdrawing money decreases the longer the funds are held. This feature adds to the flexibility and attractiveness of liquid funds for investors who might need to access their money on short notice.

Also read: What Is Systematic Withdrawal Plan (SWP)

Which is better - Overnight funds vs. Liquid funds?

Here is a more detailed explanation of the differences between liquid vs. overnight funds.

1. Investment term: Overnight funds are ideal for investors with a very short-term horizon as they mature in one business day, while liquid funds have investment horizons ranging from a few days to 91 days, giving the investor more flexibility in terms of time frame.
2. Risk appetite: An important factor to consider, whether you are going for a liquid or overnight fund, is how much risk you are willing to take. While both these debt securities have a low-risk profile, overnight funds are the least risky. Both principal and interest are recovered in a day because they invest in highly stable instruments. Liquid funds, on the other hand, can face fluctuations depending on the markets. However, they are also safer in comparison to other mutual funds.
3. Reward: Liquid funds offer more diversification since they invest across a broad range of debt instruments—some of which can have a higher risk profile, which also ensures higher returns. The investment approach in overnight funds focuses on low risk and safety, so the returns are also limited. However, they are a more stable option.
4. Ease of withdrawal: Overnight funds provide same-day withdrawal, assuring high liquidity and immediate access in the short term. Liquid funds may offer same-day or next-day redemption with a minimal exit load if withdrawn within 7 days of purchase. After this period, mutual fund withdrawals are free.

Which one should you select - Overnight funds vs. Liquid funds?

Deciding which funds are better for you between overnight funds vs liquid funds depends on three main factors:

• Investment objectives
• Immediate liquidity requirements
• Risk tolerance capacity

Overnight funds may be more suitable for investors who want minimal risk and a short-duration investment. For investors who want slightly higher returns with a longer maturity, liquidity funds are more suitable.

Conclusion

In conclusion, investing in either overnight or liquid funds depends on your financial goals and ambitions. Both of these categories provide a significant level of liquidity and safety, rendering them appropriate for short-term investments and as a means to park emergency funds.

If you want to start investing in these mutual funds, the Bajaj Finserv Mutual Fund Platform can help you find the right options tailored to your investment needs. You can browse through over 1,000 mutual fund schemes and also compare mutual funds to find the one that aligns with your risk tolerance. You can then make a lump sum investment amount in that fund or even start a SIP investment to fulfill your financial goals.

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