When investing in mutual funds, you will find various options that cater to different financial goals and risk appetites. You can put your money in places that work for you in the short, medium, or even long term. If your aim is to achieve quick gains or simply park your money safely for a short while, the three most common short-term investments are liquid funds, overnight funds, and money market funds.
You may think they are all the same since they fall under the category of debt funds. But are they really identical? Let’s find out the main differences among liquid funds, overnight funds, and money market funds and understand what importance they hold in your portfolio.
Duration of investment
Liquid funds are debt funds that invest in fixed-income securities and other debt securities that mature within 91 days. Overnight mutual funds are the shortest in terms of investment duration, with funds being invested for just a single day. On the other hand, money market funds are suitable for those looking to park their funds for a slightly longer period, up to 1 year.
Risk level
A debt mutual fund involves credit risk. Credit risk refers to the issuers’ failure to meet their interest and/or principal payment obligations.
Liquid funds carry low risk as they invest in securities that mature in up to 91 days. Overnight funds present even less risk, as they put money in securities that mature in a single day. Both include investments with a short-term nature and in highly-rated debt instruments. Money market funds, although secure, come with a marginally higher risk due to the broader range of money market instruments they invest in and their average maturity period.
Interest rate sensitivity
Securities with longer maturities usually yield higher returns but are more sensitive to interest rate changes. A change in overall interest rates can lower the value of bonds or other fixed-rate investments, posing an interest rate risk.
In liquid and overnight funds, this sensitivity remains low. A rise or fall in interest rates affects these funds less, keeping your investment relatively stable. However, money market funds hold securities with varying maturities up to a year which makes them more sensitive to interest rate changes.
Returns
Though none of these debt funds promise high returns, there exist some differences. Liquid funds can offer better returns compared to a savings account. An overnight mutual fund usually yields the least but offers the highest security. Money market funds can potentially give a little more than liquid funds but carry slightly higher risks.
Liquidity
Most mutual fund companies offer a feature called Instant Access Facility (IAF) in liquid and overnight schemes. According to SEBI guidelines, this facility allows investors to withdraw a maximum of ₹50,000 or 90% of the investment amount, whichever is lower, every day per scheme.
Money market funds also provide better liquidity just like most other mutual funds but they do not offer IAF. Thus, it may take a slightly longer time for redemption compared to liquid and overnight funds.
Conclusion
While liquid funds, overnight funds, and money market funds belong to the category of debt funds, significant differences set them apart. Each suits a different kind of investor. Liquid funds offer stability and decent returns for short-term needs. Overnight funds provide the utmost safety but give less in returns. Money market funds lie in between, offering moderate returns and some level of risk.
Your choice will depend on your own risk tolerance, how fast you need your money back, and the kind of returns you aim for. Make a smart choice and invest wisely.
