Overnight Funds vs Liquid Funds: Meaning, Differences, and How to Choose

Managing short term surplus cash effectively is a key aspect of personal and corporate finance. While keeping funds idle in a bank account may provide liquidity, it often yields minimal returns. Overnight and Liquid Funds are two popular debt mutual fund options that help investors park their money safely for short durations while earning modest returns. Understanding the differences between these funds, including their risk profile, liquidity, returns and investment horizon can help investors make informed decisions and optimize their short term cash management strategy.

Key Takeaways

• Overnight Funds - Suitable for very short term cash parking
• Liquid Funds - Suitable for short term investments beyond a week
• Risk - Overnight Funds carry minimal interest rate and credit risk whereas Liquid Funds carry slightly higher but still low risk
• Returns - Overnight Funds offer stable but lower returns whereas Liquid Funds can generate slightly higher returns due to longer portfolio maturity
• Purpose - Both are designed for short term cash management, emergency funds or temporary parking of surplus money not for long term wealth creation

What is an Overnight Fund?

Overnight funds are open ended debt mutual fund schemes that invest in instruments maturing the next business day. The fund manager continuously reinvests the proceeds from matured securities into new short term debt instruments ensuring the portfolio remains highly liquid. Due to this daily maturity structure overnight funds carry minimal interest rate and credit risk compared to other debt funds. As a result their returns are relatively lower but stable.

These funds are suitable for individuals or businesses looking to park surplus funds for a very short period. Instead of leaving idle cash in a current account, investing in an overnight fund allows you to earn modest returns while keeping the money easily accessible. They are also suitable for building an emergency fund as they provide liquidity along with some growth potential.

What is a Liquid Fund?

Liquid Funds are a type of debt mutual fund that invests in short term, low risk debt instruments. These include Treasury Bills (T-bills), Commercial Papers (CPs), Certificates of Deposit (CDs) and Collateralized Borrowing and Lending Obligations (CBLO). The hallmark of these funds is that they invest in securities with a maturity period of up to 91 days, ensuring high liquidity, low volatility and capital preservation.

When we talk about liquid fund meaning, it simply refers to this type of mutual fund that’s designed for investors who want to park their surplus cash for a short period without locking it in or taking on much risk. It’s a convenient way to earn a little extra while keeping your money easily accessible.

Overnight vs Liquid: Key differences

Feature	Overnight Funds	Liquid Funds
Investment Horizon*	Very short term typically 1 day	Liquid funds invest in securities with maturity upto 91 days
Risk	Lower credit and interest rate risk	Lower credit and interest rate risk
Returns	Lower, due to lower risk and shorter maturity	Relatively higher due to slightly longer maturity and flexibility in securities
Liquidity	Extremely liquid, can withdraw anytime	Highly liquid, but exit load applies for first 6 days
Volatility	Very low	Low, but higher than Overnight Funds
Types of Securities	Debt securities maturing the next day	Money market instruments like CDs, CPs, T-bills maturing within 91 days
Exit Load	Instant or next day redemption with no exit load	Redemption exit load free from 7th day, graded exit load if redeemed within 6 days
Best Used For	Parking surplus cash for less than a week, emergency fund	Parking surplus cash for over a week while aiming for slightly higher returns

* As mentioned in CATEGORIZATION AND RATIONALIZATION OF MUTUAL FUND SCHEMES

Portfolio & Risk Profile

Overnight Funds are designed with safety and liquidity as the top priorities. They invest exclusively in debt securities that mature the very next day, which significantly limits exposure to credit and interest rate risks. This makes them one of the lowest risk options among debt mutual funds suitable for investors who want their money to remain safe and easily accessible.

On the other hand Liquid Funds manage a slightly longer investment horizon typically up to 91 days. This gives fund managers more flexibility to invest in short term credit instruments which can offer higher returns. However, this also exposes investors to moderately higher credit, interest rate and default risks compared to Overnight Funds. Overall Liquid Funds strike a balance between liquidity, safety and the potential for slightly better returns.

Maturity & Duration Explained (Why It Matters for Risk)?

Duration is a key metric that indicates a fund’s sensitivity to changes in interest rates. Overnight Funds, with a one day maturity for their underlying securities, have almost no duration risk, making them extremely stable even when interest rates fluctuate. In contrast, Liquid Funds invest in instruments with maturities of up to 91 days. While still short term  this slightly longer duration exposes them to moderate interest rate sensitivity. As a result, returns from Liquid Funds can fluctuate modestly when interest rates change whereas Overnight Funds remain largely unaffected.

Liquidity & Redemption Timelines
 

Type of Schemes	Transaction type	Cut-off timings
Liquid Funds &  Overnight Funds	Subscription (including Switch-in from other schemes)	1:30 p.m.
	Redemption (including Switch-in from other schemes)	3:00 p.m.

 

Taxation Overview

Mutual fund taxation is subject to the latest provisions under applicable income tax laws.

For the most accurate and updated information, please refer to the latest Kotak Mutual Fund Tax Reckoner.

When to Prefer Overnight vs When to Prefer Liquid 

• Overnight Funds – Appropriate for parking surplus cash for 1 days, providing immediate liquidity with minimal risk.
• Liquid Funds - Suitable for short term investments ranging from 7 days to about 1 months offering a balance between slightly higher returns and reasonable liquidity.

Common Misconceptions (Clarifications)

• Overnight Funds are not entirely risk free - While they carry minimal interest rate and credit risk due to very short maturities, investors should still be aware that some risk exists.
• Liquid Funds do not guarantee high returns - Their returns are slightly higher than Overnight Funds because of a marginally longer investment horizon and flexibility in portfolio instruments, but they are not meant for aggressive gains.
• Both Overnight and Liquid Funds are primarily designed for short term cash management and parking surplus funds, rather than long term investment growth.

Conclusion

Overnight and Liquid Funds are both excellent tools for short term cash management, offering safety, liquidity and modest returns. Overnight Funds are best for extremely short term parking of surplus cash providing liquidity with minimal risk. Liquid Funds with a slightly longer horizon (7 days to 1 months) offer a balance of liquidity and slightly higher returns making them suitable for investors seeking short term investment options beyond a few days. While neither is intended for long term wealth creation both serve as effective alternatives to keeping idle cash helping investors earn modest returns while maintaining access to funds when needed.

FAQs

1. What is the core difference between overnight funds and liquid funds?

Overnight funds mature in one day and prioritize minimal risk whereas liquid funds invest in short term instruments up to 91 days offering slightly higher returns.

2. Are overnight funds risk free?

No fund is entirely risk free, but overnight funds carry very low interest rate and credit risk.

3. How do maturity and duration differ in overnight vs liquid funds?

Overnight funds have a 1-day maturity and negligible duration risk. Liquid funds have up to 91 days maturity and moderate duration sensitivity.

4. What portfolio instruments do each typically hold?

• Overnight Funds - Primarily invest in Treasury Bills (T-Bills), overnight repos and call money focusing on instruments that mature the next business day to maintain high liquidity and minimal risk.
• Liquid Funds - Invest in short term debt instruments such as Commercial Papers (CPs), Certificates of Deposit (CDs) and short term government securities allowing slightly longer maturities while still ensuring capital preservation and liquidity.

5. Do liquid funds always have exit loads while overnight funds do not?

Liquid funds levy exit loads for very short term redemptions (upto six days) whereas  overnight funds do not have exit loads.

6. Which category suits parking cash for a few days vs a few weeks?

Overnight funds are suitable for a few days, while liquid funds suit slightly longer durations of a few weeks.

Disclaimers

Investors may consult their Financial Advisors and/or Tax advisors before making any investment decision.

These materials are not intended for distribution to or use by any person in any jurisdiction where such distribution would be contrary to local law or regulation.  The distribution of this document in certain jurisdictions may be restricted or totally prohibited and accordingly, persons who come into possession of this document are required to inform themselves about, and to observe, any such restrictions.

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