What are overnight funds and how can you invest in them?

Overnight funds

Open-ended debt funds having a one-day residual maturity are known as overnight funds and they are invested into overnight securities, hence their name. 

The Asset Under Management (AUM) is kept in cash at the beginning of each business day. Subsequently, this cash is invested into overnight funds. These mature the very next business day. 

The cash is often used by fund managers to buy additional bonds afterward, and the process repeats. 

In this article we will go through what overnight funds are, how they work, and will also try and understand various advantages and disadvantages of the same.

The prime objectives of overnight funds are to allow investors to make better use of their cash reserves. To figure out how overnight funds function, you must first understand where they invest and how they create returns.

How do overnight funds work?

Overnight funds often invest into repos that are reversible overnight like CBLOs, better known as Collateralized Borrowing and Lending Options, as well as other debt or money market instruments that expire in a day to comply with SEBI regulations. 

Each day, fresh overnight securities are added to the portfolio of overnight securities. This law prohibits overnight funds from investing in deposits or specified hazardous debt instruments, to minimize the probability of a portfolio defaulting. 

Also, these funds only make money by paying interest on certain debt holdings. Because it only takes a day for the securities to mature, there is no chance of generating capital gains. The earnings on these funds, in reality, are based on the overnight lending and the rates of borrowing. When rates of interest fall and short-term liquidity are high, overnight market rates decrease as well, and vice versa.

Advantages of Overnight funds

  • Liquidity

Overnight funds are often free of entry and exit charges, making them very liquid. This implies that in the event of an emergency, investors may readily redeem their assets without risking their principle.

  • Better use of leftover cash 

Overnight funds are a good alternative for investors who would like to make the most of their excess cash reserves while taking the least amount of risk. 

Unlike most conventional savings alternatives, which have long terms, overnight funds allow investors to make money in a shorter period.

  • Low-risk factor

The factor with low-risk Overnight funds has a low-risk component, making them suited for investors with a modest appetite for risk. 

It also benefits those people who have a cautious approach to investing.

  • Protection against market volatility

The Reserve Bank of India’s (RBI) interest rate adjustments, as well as changes in a borrower’s credit rating, have a little to non-existent influence on overnight mutual funds. 

Their limited investment horizon protects investors from risks such as liquidity instability, credit risk, and aims to protect them from market volatility.

  • Cost-effectiveness

Because their debt assets are passively managed, overnight funds are minimal debt mutual funds.

  • Enhanced security 

While risk cannot be eliminated, the risk involved with these types of funds is one of the lowest among debt funds, with little credit risk and nearly nil interest rate risk. 

Because these funds mature in one day, it is very improbable that they would fail on interest payments. In a nutshell, overnight funds are less risky than liquid funds.

Disadvantages of Overnight funds

  • The risk-reward analysis for a small investor as a whole is not feasible. Investing in overnight mutual funds is a great way for small investors to obtain access to liquidity, but the procedure of monitoring the fund’s progress for each day and being engaged in the procedures before and after might be a little too time-consuming for many investors. 
  • Overnight funds are not a viable option for investors looking for liquidity as well as a good degree of stability.
  • The improved/better return element isn’t as important as previously thought. It’s also worth noting that the returns on overnight mutual funds aren’t substantially different from those on fixed deposits or bank savings accounts, which might be a drawback for certain investors.

Who are overnight funds best suited for?

Risk-averse individuals who wish to invest extra cash in a fund for a limited period might benefit from overnight mutual funds. Given below are the things you need to consider before investing in overnight funds.

  • Overnight funds are suited for investors with a short investment horizon, since they may be redeemed even after a single day of holding the units in their portfolio. Unlike liquid funds, overnight funds don’t impose an exit fee for withdrawals made in less than a week after purchase.
  • Overnight mutual funds are also a good option for equity fund investors who don’t want to take big chances until they make the switch to equity funds.  Investing in equity funds and keeping the money in a mutual fund overnight are both possible with a strategy such as an STP. This can be used to move funds from overnight funds to equity-based funds.

What to consider before investing in overnight funds?

Investments in overnight funds may be repaid at any time, making them equivalent to regular savings. 

As a result, overnight funds usually give lower returns. Yet, there is some variance in the returns and cost ratios of overnight mutual funds in the market.

A prudent investor would conduct market research and choose funds with a track record of strong returns at a reasonable price. 

Investing in an overnight fund should be in line with the individual’s investment objectives and strategy and not just a response to the most recent credit default occurrence.

How are overnight mutual funds taxed?

Just like debt funds, overnight mutual funds are also taxed in a similar manner since overnight plans provide profits for investors in the form of capital gains and dividends.

There will be no lock-in period for investors in the income tax bracket who receive dividends, and the overnight fund will remove tax at source from the dividends before they are paid out or reinvested. 

When completing their yearly tax return, the investor may claim a tax credit for taxes that have been deducted at the source. 

Units acquired at a lower price and redeemed at a higher price are referred to as capital gains. Capital gains tax rates are determined by the length of time an investment is held.

The tax on short-term gains (STCG)

Short-term capital gains are those gained by an investor who holds a debt fund investment for less than three years (STCG). 

In the investor’s net income tax return, the STCG profits are included and taxed as per the investor’s tax bracket.

The tax on long-term capital gains (LTGC)

A long-term capital gain is realized when an investor sells his or her shares in an overnight mutual fund after more than three years of ownership (LTCG). 

There is indexation on long-term capital gains (LTCG), which are taxed at a rate of 20 percent (plus any relevant surcharge and a 4 percent health and education cess). By using cost inflation index, investors can increase the purchasing price.

Overnight funds work differently in various scenarios, and knowing how they work can help you get the most out of your investments. 

When it comes to debt mutual funds, it would be good if you could also clear up your misunderstandings about the risk-reward factors. Your overnight mutual fund investments in India will benefit from this knowledge. Investing in mutual funds should only be done after careful consideration of your objectives, time horizon, and level of risk tolerance.


Overnight security funds contain high liquidity and multiple risk factors that need to be properly understood before investing. 

Even though overnight funds seem to be the go-to option for various companies and institutions trying to invest their extra cash into a short-term benefit goal, the same isn’t quite beneficial for small-scale businesses and business owners. 

It is always a viable option to educate yourself about all the practicalities and risk factors of the market before trying to invest. 

Make sure you do not get yourself into schemes with false promises and have proper knowledge of what you invest in. Stay away from urban myths and look into reliable sources for facts on overnight security funds before investing.

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