Overnight Funds: The Shortest Rung on the Debt Ladder

The fund lends money overnight, usually through very short-term arrangements backed by government securities. The next business day, the money comes back with a small amount of interest, and the fund lends it again.

Because every loan matures the very next day, there is almost no time for interest rates or a borrower situation to change. That is why the value is so steady.

The lending is typically done in a very secure way, backed by government securities, which adds to the steadiness. It is a very plain, predictable kind of fund, and that is exactly its purpose.

Both are used for parking money. The difference is how long their holdings last.

Overnight funds hold instruments that mature in one day. They are the steadiest option.

Liquid funds hold instruments up to about three months. They can earn a little more, but carry slightly more movement and a small amount of credit risk. Our page on liquid funds covers them.

In practice, the difference in outcome between the two is small for short periods. The choice is mostly about how steady you want the money to be.

For very short parking or maximum steadiness, overnight. For a few weeks to a few months, many people use liquid funds.

A savings account is instant and simple, and it is where most day-to-day money should stay.

An overnight fund is a market-linked mutual fund. It usually takes a working day to get money back, and it is not a deposit. Some people use it for larger sums waiting for a short period. Our page on mutual funds versus a savings account explains the differences.

• Money waiting a few days for a planned payment, such as a property registration or fees.
• Money between selling one investment and buying another.
• Businesses parking surplus cash for short periods.
• As the source fund for a transfer plan where the money will move out quickly.

Our page on the systematic transfer plan explains how a parking fund feeds another fund in steps.

They are not built for long-term growth. Money kept in an overnight fund for years will likely struggle to keep up with rising prices, as our page on inflation and your savings explains.

They are also not usually the best home for an emergency buffer that you want instant access to at any hour, since redemptions follow working days and cut-off times.

This is among the lowest-risk mutual fund categories. Their riskometer is usually the lowest level. Our page on the riskometer explains the scale.

But they are still market-linked products, not deposits. The value is calculated daily, and in rare conditions it could dip slightly. Anyone calling them risk-proof is overstating it.

Redemption money is usually credited on the next business day, depending on the time of your request and the cut-off rules. Our page on cut-off time explains how timing works.

Most such schemes have no exit load, so you can move money in and out without a penalty for leaving early. Check the scheme documents to be sure.

Say you have sold an old property and the money will go towards a new flat whose registration is three weeks away.

Keeping that money in an overnight fund for three weeks keeps it steady and ready, rather than sitting idle, and there is usually no exit load for taking it out. You would plan the redemption a day or two before the registration date.

That is exactly the kind of short, dated job this category is built for.

Because returns are modest, cost matters a lot. A small difference in expense ratio can take a noticeable share of what you earn.

Compare expense ratios between schemes in this category, and between direct and regular plans. Our page on expense ratio explains how costs are taken.

Many small businesses and traders keep surplus cash in overnight or liquid funds between the time money comes in and the time bills are paid.

If you run a business, check how quickly you usually need money and how large the surplus is. Keep day-to-day working money in the bank, and only park true surplus. Our page on investing as a business owner discusses cash flow planning.

For tax purposes, they are treated as debt funds. The rules for debt funds have changed more than once, and we do not quote rates.

Our page on mutual fund taxation covers the structure, and a tax adviser can confirm your own situation.

You can invest in these schemes like any other mutual fund, online or on paper, with a lump sum. SIPs are possible but uncommon, since the purpose is usually short parking.

If you prefer paper, our page on investing offline explains the steps.

Think of debt funds as a ladder by holding period: overnight at the bottom, then liquid, then ultra-short and short duration, then medium and long duration at the top.

The further up you go, the more the value can move with interest rates. Our pages on short duration funds and arbitrage versus liquid funds cover the next steps.

• One-day lending, repeated every business day.
• Very steady, but still not a deposit.
• Good for parking money for days or weeks.
• Not for long-term growth.

We are distributors rather than investment advisers and we recommend no schemes. If you want help deciding where short-term money should sit, get in touch.