In the previous episodes, you would seen us talking about investing the emergency funds in liquid or overnight funds.
But what are Liquid / overnight funds?
What makes them the best choice to invest the emergency fund?
Are there any risks involved?
What returns can be expected?
When should one invest in liquid / overnight funds?
All this and more in this new episode of Money Ki Baat.
Find the Risks with Debt Investments Episode here: https://youtu.be/lWS16uERyX4
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Disclaimer: This podcast is for educational purposes only. Anything said should not be construed as advice. Make your investments only after consulting your financial advisor.
Hi Guys, I am Anmol Gupta from the show "Money Ki Baat". You must have heard me saying a lot of times that you should invest in Liquid Funds or Overnight Funds for emergency purposes.
But what are Liquid and Overnight Funds? These are categories of Mutual Funds, right?
However, what is so special about these Mutual Funds that they can be used for emergency purposes?
Liquid Funds and Overnight Funds are types of Debt Mutual Funds which means they invest in bonds or other instruments that give you interest. They do not invest in Stocks at all.
Now, there are different types of Bonds.
In my episode on "Risk with Debt Investments", I spoke about two primary risks involved with Debt instruments.
1. Credit risk or Default risk, i.e. when the borrower fails to pay back the interest rate and the principal.
2. Interest Rate risk which is a little complex to understand. But, in short, the longer the maturity period, the higher is the Interest Rate risk, and adjacently the bond price can also fluctuate like stocks.
To understand this in details, I would recommend you to watch the episode on "Risk with Debt Investments".
Liquid Funds are debt funds that invest in Bonds whose maturity period is less than 91 days. In this case, the interest rate risk involved with liquid funds is very low because interest rates are unlikely to fluctuate in a short period of time. But Liquid Funds may hold credit risk or default risk which means that there is a chance that the borrower can default. While investing in Liquid funds, we must ensure that the bonds are high rated, preferably, AAA rated Bonds.
In case of Liquid Funds, Interest Rate risk is low and default risk depends on the quality of the bond in which the fund has invested. Normally, Liquid Funds invest in high quality bonds due to which default risk involved is also comparatively less.
Overnight Fund is a new category of Mutual Funds that invests in Bonds with a maturity of 1 day. The bonds that mature in 1 day does not involve any Interest Rate risk. The interest rate cannot fluctuate in a single day. Therefore, Overnight Funds are even safer than Liquid Funds. Liquid funds are less riskier than other debt funds. But, Overnight funds are even less riskier than Liquid Funds. Default risk involved with Overnight Funds is also negligible because it is very unlikely to default in a single day.
Now let's talk about returns.
Liquid Funds are currently giving 5-6% returns, which is slightly more than Fixed Deposit in most of the cases.
Overnight funds are also giving 4.5-5% returns per year which are slightly lesser that Liquid Funds.
Until a year before, Liquid Funds were giving upto 7% returns.
Now the most important question is, when you should invest in Liquid Funds or Overnight Funds.
When you have some savings or you want to park your money somewhere for a short period of time, but you want better returns than Fixed Deposits without taking more risk, then you can invest in Liquid Funds.
Typically, for accumulating emergency fund, we can invest in Liquid Funds. However, you must remember, if you withdraw money from Liquid Funds within 7 days, then you have to pay exit load. Earlier, Liquid Funds did not charge any exit load.
Therefore, if you plan to redeem your money within 7 days, do not invest in Liquid Funds. In such a case, you can invest in Overnight Funds, where you can put a purchase and redemption order in a single day.
Unless you invest huge amount of money, do not expect a lot of returns from overnight funds by investing in a day.
This is because, 4-5% is annual return. Hence, the return will be too less for a single day. Typically, those companies who want to invest a huge amount of money for 2-3 days can invest in Overnight Funds.
Therefore, crux of the matter is you can invest in Liquid Funds or Overnight Funds for short term needs.
Liquid Funds are very safe than other debt mutual funds, but Overnight funds are even safer than Liquid Funds.
If you want to withdraw money within 7 days, then you can invest in Overnight Funds, and if you want to invest, let's say, for 3-4 months, then you can invest in Liquid Funds.
However, Liquid Funds and Overnight Funds are riskier than other Bank Deposits because Interest rates are not guaranteed. Returns might fluctuate.
So I hope guys, you have understood why we use Liquid and Overnight Funds for emergency purposes.
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