Overnight Funds - Definition, Taxability and How to Invest?

Overnight Funds are a safe and smart way for people to invest money and make some profit without taking big risks. Let’s learn more about Overnight Funds, why they are a good choice, delve into points to consider before investing and show you a step-by-step investment approach.

What are Overnight Funds?

Overnight Funds are a category of Debt Funds introduced as part of SEBI's Mutual Fund reclassification in 2018. These Funds are like a type of Debt Fund, which means they deal with Loans and Debts. What makes them different is that they only invest in things that last for just a day. Unlike regular Debt Funds, these Overnight Funds are all about short-term investments and come with some great benefits. Firstly, they are super safe. There are zero worries about interest rates increasing or getting back money you have lent to people. This safety comes only investing in things that last for one night, reducing the chances of making or losing big money. Another good thing is that they do not cost a lot. They manage things in a simple way that keeps the fee low. Most of these funds don't charge more than 1%, which is good news for people looking to invest without spending too much. In simple terms, Overnight Funds are like a safe and low-cost way to invest your money, focusing on short-term stuff that can bring in some profits. It's all about keeping things easy and secure for investors.

How Overnight Funds Work?

Overnight funds invest in very short-term instruments that mature in just one day. These include instruments like CBLO (Collateralised Borrowing and Lending Obligation) and repo agreements, which are safe and low-risk.

Fund managers buy these one-day securities daily, and reinvest the returns the next day into similar instruments. Since these funds don’t lock in money for long, they are not affected much by market movements or interest rate changes. This makes them a great way to park idle cash safely while earning a bit more than keeping it in a savings account. They are ideal for conservative investors looking for minimal risk.

Features of an Overnight Fund

The important features of an overnight fund to know about are:

1. These are open-ended debt funds that invest only in securities that mature in one day. This way these are less risky.

2. The funds offer a safe way to get quick returns which remains unaffected by interest rate changes or any credit defaults.

3. There is no entry or exit load related to these funds. It makes them highly liquid, meaning you can withdraw anytime.

4. Such funds are ideal for people who are searching for low-risk investment options and want to park their money for a short time.

How to Find the Best Overnight Fund?

To find the best overnight fund, look at factors like past performance, fund manager experience, expense ratio, and the fund’s liquidity. You can invest through ICICI Bank’s Demat and Trading Accounts. First, complete your KYC to get started. A lower expense ratio ensures better returns over time. Also, check if the fund has a stable record of returns without too much fluctuation. Choose one that suits your short-term goals, offers easy redemption, and is backed by a trusted AMC. Always review the fund factsheet before investing.

Advantages of Investing in Overnight Funds

Let’s understand why investing in Overnight Funds is a smart move. These Funds have advantages that make them a great option for certain people:

Super Safe: Overnight Funds are considered the safest among Debt Funds. They invest in assets with a residual maturity of just one day, minimising exposure to interest rate risk and virtually eliminating credit risk. The short-term nature of these investments reduces the likelihood of default on interest payments, providing a high level of safety for investors. 

Not Expensive: Overnight Funds typically operate with low expense ratios. Their passive management approach, focusing on short-term debt securities, resulting in lower fund management costs. This cost-effectiveness enhances the overall returns for investors, as a significant portion of the earnings are not consumed by high management fees.

Flexibility is the Key: Investors in Overnight Funds enjoy flexibility in terms of holding periods. They can enter or exit the investment as needed, providing liquidity and allowing for quick access to funds. This flexibility is particularly beneficial for those with short-term financial goals or unpredictable cash flow needs.

Stability and Predictability: Since Overnight Funds invest in short-term securities, the fund's value does not exhibit significant volatility. This stability can be reassuring for investors looking for a secure and predictable investment option. The predictability of returns, primarily derived from interest income, makes Overnight Funds suitable for conservative investors seeking capital preservation.

Tax-friendly: Here is some good news for your taxes! Overnight Funds, just like other Debt Funds, get special advantages. If you keep your money in these funds for more than three years, the tax you pay on the money you make is lower than what you would pay on interest from a regular Savings Account. Also, there is something called indexation that might help reduce your tax bill. So, it's a win-win!

Why Should You Invest in Overnight Funds?

Read these reasons to invest in an overnight fund:

1. The funds are a good option if you are looking to earn a small return on your money that is sitting idle, without much risk.

2. These funds are quite a safe way to invest money and get decent returns, that often mature in a single day. It also means there is no to less impact of interest rate changes.

3. For someone who is a conservative investor, or looking for short-term cash, these funds can be a good choice.

4. You can expect a low-risk, and high-liquidity nature from these funds which makes them ideal for temporary investment. 

Things to Consider Before Investing in Overnight Funds

Investors must consider several factors before investing in Overnight Funds to ensure that this investment aligns with their financial goals and risk tolerance. Here are the key things to consider before investing in Overnight Funds:

1. Return Expectations

Overnight Funds are designed to prioritise safety and liquidity over high returns. Investors should set realistic expectations, understanding that these funds are comparable to a Savings Account, than high-yield investments.

2. Variability among Funds

While Overnight Funds, as a category are relatively low-risk, there can be variations among individual funds. Analyse the market and choose funds with a consistent track record of good performance and lower costs to optimise returns.

3. Expense Ratios

Evaluate the expense ratios of different Overnight Funds. Lower expense ratios contribute to higher net returns for investors. Compare the costs associated with managing the fund and choose funds that offer a balance between cost-effectiveness and performance.

4. Tax Implications

Understand the Tax implications of investing in Overnight Funds. While Debt Funds may have Tax advantages over traditional Savings Accounts, it's essential to be aware of the taxation on capital gains and potential benefits like indexation.

5. Financial Goals and Strategy

Align your investment in overnight funds with your broader financial goals and investment strategy. If you have specific short-term financial objectives or liquidity needs, overnight funds can serve as a valuable tool.

How to invest in Overnight Funds?

Investing in Overnight Funds is a straightforward process. Here are five key pointers to guide you through the steps:

Selecting the Right Fund

Before initiating an investment, it is essential to carefully evaluate Overnight Funds based on two key criteria - returns and expense ratio. While returns are crucial, investors should also prioritise funds with lower expense ratios, as higher expenses can impact the overall return on investment.

Prefer SIP for Seamless Investment

Investing in Overnight Funds can be made seamless and systematic through the SIP (Systematic Investment Plan) offered by reliable financial institutions like ICICI Bank. It allows investors to invest a fixed amount in their chosen fund regularly. This disciplined approach to investing, helps mitigate market fluctuations and allows for the benefit of Rupee Cost Averaging.

Steps to Invest in SIP:

• Account Setup:Open a Mutual Fund Investment Account with the Bank

• KYC Compliance:Ensure your Know Your Customer (KYC) compliance is in place

• Fund Selection:Choose an Overnight Fund that aligns with your investment goals

• Investment Amount:Decide on the amount you want to invest through SIP

• Frequency:Select the frequency of your investments (monthly, quarterly, etc.)

• Duration:Determine the duration for which you plan to continue your SIP.

• Monitoring and Adjusting: Regularly monitor the performance of your chosen Overnight Fund and make adjustments to your SIP as needed. Stay informed about market trends and fund performance to ensure your investment strategy remains aligned with your financial goals.

Taxation Rules of Overnight Funds

The taxation rules on overnight funds work similar to debt mutual funds. If you sell your investment within 3 years, then the gains are added to your income and taxed as per your income tax slab. In case you hold it for 3 years and more, then the gains are taxed at 20% with indexation, which reduces your taxable amount by adjusting for inflation.

If you choose the dividend option, you will have to pay 29.12% as Dividend Distribution Tax (DDT). Most investors now prefer the growth option to avoid the high tax on dividends. So, always consider the holding period and choose the right tax-efficient option.

Conclusion

Overnight Funds present a secure and low-cost investment option for individuals seeking stability and liquidity in their investment portfolio. With zero interest rate risk and minimal credit risk, these funds serve as a safer alternative to traditional Debt Funds. While offering relatively lower returns, Overnight Funds are particularly suitable for investors with a very short investment horizon or as a medium to route funds into other long-term funds.