Overnight funds owing to their unique benefits and features have gained enormous importance in the financial landscape. Such funds offer you the opportunity to generate stable returns on your investments while lowering the risks. However, like other investment instruments, overnight mutual funds even have their set of downsides. Discussed here are the risks associated with overnight funds and the potential solutions to meet those risks to attain expected returns. 

Risks of investing in overnight funds and their solutions

Lower returns than other mutual funds

While overnight mutual funds provide safety and stability, they yield lower returns than other kinds of mutual funds. The basic reason for this is that overnight mutual funds invest in short-term products with lower yields. To mitigate this drawback, you may consider diversifying your investment portfolio. Just by allocating a part of your funds to instruments yielding higher returns like equity mutual funds or debt mutual funds with higher durations, you can potentially increase your thorough returns while still leveraging the benefit of stability offered by the overnight fund. 

Interest rate risk 

This is the next risk associated with overnight funds. Such funds invest your investible in fixed-income assets that are sensitive to interest rate changes. When the rate of interest rise, the value of the existing fixed-income instruments and securities falls, resulting in considerable capital loss. To meet this risk, you can take up a cautious approach by figuring out the rate of interest trends and adjusting your investment allocation accordingly. Also, you can consider opting for overnight mutual funds with shorter maturity periods owing to their lower susceptibility to the rate of interest fluctuations. 

Credit risk 

While such funds invest in low-risk and high-quality debt instruments, there still is a chance of issuers’ default. To minimise this risk, you must carefully evaluate the securities’ credit quality of the fund. Ensure you invest in overnight mutual funds managed by high-end asset management companies holding a good past record of risk management and credit analysis. Moreover, diversifying investments throughout various overnight funds can assist lower exposure to a single issuer. 

Market liquidity risk

Overnight funds depend on the liquidity of underlying securities. In case there is any unexpected lack of market liquidity, it might become challenging to sell such securities at decent prices, affecting the overnight fund’s NAV (net asset value). To manage this risk, you can select overnight fund schemes that invest in instruments and securities holding high liquidity and traded on regulated exchanges. Constant monitoring of market levels and maintaining a proper asset allocation strategy can assist meet market liquidity risks. 

Conclusion

Overnight funds offer safety and stability, making them prudent for short-term investment. While such funds have some drawbacks such as interest rate risk, lower returns, market liquidity risk, and credit risk, you can use specific solutions to meet and manage such risks. Monitoring rate of interest trends, diversification, evaluating credit quality, selecting reputable and renowned fund managers, and factoring in market liquidity are crucial strategies to optimise your returns and manage the risks effectively. Such funds are best for meeting your short-term life goals spanning up to three years, creating contingency funds and adding capital preservation features to your portfolio.