Difference Between Overnight Funds vs Liquid Funds

Selecting the best short-term investment option, particularly with overnight and liquid funds, can be confusing. Overnight and liquid funds provide safety, low risk, and liquidity, which is why those who want to save conservatively seek these investments. But which option best fits your goals as an investor?

This article outlines the most significant differences between overnight and liquid funds to evaluate your next possible investment. Continue reading to determine the fund type best suited to your needs and make better choices for investing your idle money.

Debt funds are mutual funds that predominantly invest in fixed-income securities, including government bonds, corporate bonds, treasury bills, and money market instruments. These investments generally come with lower risk and more stable returns. Two common types of debt funds are:

• Overnight Funds: These funds invest in securities that will mature in one day, such as collateralised money market instruments backed by government securities.
• Liquid Funds: Invest in debt instruments maturing within 91 days. These are ideal for parking surplus cash for several days to a few months.

Overnight funds are debt mutual funds that solely invest in securities with a one-day maturity. The primary purpose of these funds is to provide capital safety and high liquidity, making them perfect for short-term parking surplus cash or temporarily unused cash.

The fund manager continuously reacquires new one-day securities. At the same time, the previous holdings mature daily, maintaining minimal duration and credit-risk exposure, as the manager reinvests on any day. These funds remain a safe and liquid mutual fund investment for cautious investors looking for safety and instant liquidity in their cash outlay.

Liquid funds are a type of debt mutual fund scheme that invests in short-term debt securities with maturities of less than 91 days. These securities consist of treasury bills, commercial papers, certificates of deposits, and other short-term instruments. The primary objective is to provide liquidity with good returns.

As holdings are reinitialised daily, such funds do not face a material interest rate or credit risk. They represent a secure means for investors who wish to temporarily invest idle funds. It is ideal for individuals and institutional investors as a substitute for savings accounts, mainly for low-risk liquidity management.

Overnight and liquid funds are part of the debt mutual fund and follow similar tax rules.

• Short-term capital gains on units held before three years of holding are to be taxed according to the investor's income tax slab.
• Longer-term capital gains on units held for more than three years were taxed at 20%, with an indexation benefit as well.
• However, for units purchased on or after April 1, 2023, the indexation benefit has been removed, and all capital gains will be taxed as per the income slab, regardless of the period the units are held.
• Dividend income is also added to the investor's total income and taxed as per the slab. However, in the dividend option, the investor must also pay an additional 29.12% DDT (Dividend Distribution Tax).

Both overnight funds and liquid funds follow the same tax structure; however, due to regulatory changes, both are way less tax-efficient for the long-term holding period.

The choice between overnight and liquid funds will primarily be based on your financial objectives, risk appetite, and liquidity requirements.

• Overnight funds are best suited if you want to park funds for a very short time and your main concern is capital protection and instant access. They are helpful, particularly if you do not wish to incur any exit fees or penalties while withdrawing.
• Liquid funds, however, are appropriate for slightly longer short-term investments of between two or three weeks and three months. They are suitable if you are looking for slightly higher returns and can tolerate a marginal rise in risk.

Selecting the appropriate fund, considering your investment period, desired return, and liquidity preference, ensures maximum returns without any risk to your capital.

Overnight and liquid funds have a specific purpose in short-term money management. If you want to place the highest importance on capital protection and immediate liquidity, overnight funds are the solution. If you can keep your investments for a little bit longer and wish for higher returns without taking much risk, liquid funds are better.

You can maximise your idle funds by matching your risk tolerance, investment horizon, and liquidity requirement with the proper type of fund.

Disclaimer: The information provided on this website is for general informational purposes only and should not be construed as financial, investment, or legal advice. While we strive to provide accurate and up-to-date content, we do not guarantee the completeness, reliability, or suitability of the information for your specific needs.

We do not promote or endorse any financial product or service mentioned in these articles. Readers are advised to conduct their own research, consult with financial experts, and make informed decisions based on their unique financial circumstances. Any reliance you place on the information provided here is strictly at your own risk.