Mutual fund schemes in India cater to a variety of investment objectives, and it is no surprise that the industry’s total Assets Under Management (AUM) reached the ₹ 50.78 lakh crore mark for the first time in December 2023. Of the sixteen categories of mutual funds that are specifically designed for different investment objectives, three stand out as low-risk investment options meant for the short term: Overnight funds, liquid funds, and ultrashort funds.
What are overnight, liquid, and ultrashort funds?
Here are the brief definitions of these three sub-categories of debt mutual funds:
- ‘Overnight funds’ are debt mutual funds that invest in overnight securities that have a residual maturity of one day. In other words, Overnight funds invest in debt securities that mature the next day. These are low-risk mutual funds since they are not exposed to interest rate risk or default risk like other categories of debt funds.
- Liquid funds invest in highly liquid money-market instruments and debt securities that have a very short tenure such as Treasury Bills, Commercial Papers, and Certificates of Deposit. They have a residual maturity of up to 91 days.
- ‘Ultrashort funds’ invest in short-term debt securities with a residual maturity between three and six months. They are considered less risky as compared to long-term bonds or equity funds, and they offer high liquidity.
What are the key features of these three funds?
Here are the key featuresof overnight funds, liquid funds, and ultrashort funds:
- Overnight funds mature in a day’s time, whereas liquid funds have a maturity period of up to 91 days, and ultrashort funds can have a maturity period of up to six months.
- Overnight funds and liquid funds offer high liquidity, whereas ultrashort funds offer lesser liquidity than the former two.
- The mutual fund house charges no exit load from an Overnight Fund investor. However, liquid fund investors and ultrashort fund investors must bear an exit load.
- Overnight funds invest in money-market securities whereas liquid funds and Ultrashort funds invest mostly in Treasury bills and commercial papers.
- Returns earned from all three funds are taxed based on the investor’s slab rate.
When are these three funds recommended to investors?
Before deciding on which fund to choose between these three, the investor must analyse their investment horizon and liquidity requirements. Investors looking to park their investment money for a few months (3-6 months) can consider Ultrashort funds as an option. Liquid funds are suitable for investors looking to park their savings for a shorter term (1-3 months). Investors who do not wish to take high risks and only wish to park their savings for a couple of days can opt for Overnight mutual funds.
Analysing one’s investment objectives is very crucial to picking the right investment scheme. The investor should use a mutual fund calculator to estimate their returns at the end of their investment horizon. This can help the investor plan for their investment in advance and choose the right fund among these three categories of debt funds.