If you often have surplus cash sitting idle, overnight funds provide an avenue to earn a better return than a regular savings account. These funds invest in very short-term debt securities, with funds invested today maturing the next business day. With safety and liquidity as core features, overnight funds are gaining popularity with Indian investors.

But how do you select the best overnight fund for your needs? One often overlooked yet vital factor is the expense ratio.

What is an expense ratio?

An expense ratio represents the annual fee an investor pays to the fund house for managing their investment. This fee covers operational costs, fund manager salaries, and other expenses. In a sense, it's the cost of running the overnight fund. Expense ratios are expressed as a percentage of your total investment.

The impact of expense ratios on overnight funds returns

Even relatively small differences in expense ratios can have a noticeable impact on your net earnings, especially over time. Let's illustrate this with a scenario:

• Fund A: Expense Ratio - 0.20%
• Fund B: Expense Ratio - 0.50%
• Investment Amount: Rs 1,00,000
• Holding Period: 1 year

Assuming both funds deliver a 5% return before expenses, here's what the impact looks like after costs:

• Fund A: Net Return - Rs 4,800
• Fund B: Net Return - Rs 4,500

In this case, a seemingly small 0.30% difference in expense ratios results in a Rs 300 gap in your earnings after a year.

How to choose the right expense ratio

Here's how to prioritise expense ratios when choosing an overnight fund:

Compare returns: Historically high overnight fund returns alone don't tell the full story. Prioritise funds with strong net returns (those calculated after deducting the expense ratios). This metric is the truest reflection of your likely earnings.

Analyse expense ratios: Conduct a thorough comparison of expense ratios offered by different overnight funds. Always opt for funds with lower expense ratios.

Consider track record: Don't rely purely on a single performance snapshot. Research funds with a proven history of consistent returns and couple that information with competitive expense ratios.

Consider other factors: Remember, other considerations like the credit quality of the fund's holdings and the fund house's overall reputation also play a part in your final decision.

Additional considerations

Risk appetite: Overnight funds are relatively safe, but aligning your investment choices with your overall risk tolerance is vital.

Financial goals: Determine if an overnight fund fits your short-term financial needs before investing.

Parking surplus funds: If excess money needs a safe place with some flexibility, overnight funds are a good solution. You can access your money quickly if needed while earning interest.

Who should invest in overnight funds?

• Investors with low-risk appetite: Overnight funds offer stability and minimal volatility.
• Investors seeking to park surplus cash: These funds help earn interest on your idle money with easy access.
• Investors planning to move to equity funds: Overnight funds are a safe temporary parking space before you shift your investments to equities.

Conclusion

When choosing an overnight fund, take into account the importance of the expense ratio. Lower expense ratios can significantly improve your net returns over time. Consider your online investment goals, risk tolerance, and desired holding period to select an overnight fund that aligns with your financial needs.