Receiving passive income is the "blue dream" of everyone, and not only the investor. We wrote about the options for passive earnings in our article "How to receive passive income monthly": buying and renting out housing, deposit, accumulative and investment insurance, investments in the stock market. Each of these options, in addition to its pros, cons, risks, has certain time parameters – months and even years. What about the day/night earnings option? At first glance, this option seems absurd and even similar to fraud. And in most cases it is. But there is also a completely legal one – overnight transactions.
The overnight option is one of the parameters known to almost every investor. In simple words, it means that you lend your assets (securities or money) to a broker overnight, and for this the broker pays you a certain% of the loan amount. It seems tempting - "money works while you sleep, and markets don't trade." But not everything is so clear. In this article, we will try to understand the internal component of overnight transactions, the benefits and risks for the investor.
What is Overnight
Before we begin to dive into the terminology, let's clarify what is "investment"? In a general sense, investments are reduced to the investment of free cash in order to increase them - due to the increase in the exchange rate of securities, as well as as a result of the payment of dividends on shares (if they are provided) or coupon payments on bonds. It would seem, why tell the obvious things, and what does the overnight deal have to do with it? The connection here is the most direct. The investor invests free cash, and with a competent investment, he makes a profit. At the same time, each owner of "securities" can carry out the necessary financial transactions "Buying" and "Selling" their assets in securities right during trading, but as soon as trading on the exchange closes, the assets actually remain "frozen" before opening without the opportunity to work with them. And so I want them to always work, even when we sleep. It is during the "downtime" of assets that the opportunity arises to earn overtime on them by resorting to overnight transactions.
Overnight is a financial term referring to short trades. In the banking sector, these are loans or deposits for 1 day. For investors – short-term lending to a brokerage organization - when an investor lends his valuable assets or free cash to a broker overnight. Each of the parties benefits from such short transactions:
- The one who provides free funds receives a reward in the form of a certain percentage.
- The one who borrows funds covers short–term needs for liquid funds or simply earns using borrowed funds.
Thus, an overnight transaction for an investor is an additional earning tool while he is "sleeping".
The term "overnight" is most often used in the banking environment. This term means short-term interbank lending and short-term deposits for a day. Loans for one day are not provided to individuals, but the overnight service can be considered as a one-day deposit for citizens placed in a bank.
Overnight in the banking sector
Initially, overnight transactions originated in the banking sector. When a large credit institution needs additional funds, then one of the options for closing this need is an interbank overnight. An overnight transaction is the best solution for a credit institution to attract borrowed capital for a short period.
Interbank loan overnight
Such a loan is granted for one day or night. In fact, this is a super-short-term loan. As a result, one bank issues a loan to another bank. This is convenient for all participants in the transaction, because the lender organization makes a profit from the loan issued, and the borrower organization solves its temporary financial problems at the expense of the funds received, without wasting time on additional registration.
A short loan period and sufficiently large loan amounts - measured in tens and hundreds of millions of rubles - are the main "trump cards" in such transactions. Interbank loans on loans are issued only in Russian rubles, because the exchange rate can change very much overnight. A stable overnight interest rate allows market participants to maintain access to short-term liquidity, plan liquidity management and its redistribution. The central bank ensures that the deviations of the overnight rate from the interest rate of the central bank itself are small, and keeps the overnight interest rate within a narrow interest corridor, not allowing it to go beyond it.
The current rate on overnight loans can be found on the website of the Central Bank.
Overnight interbank deposits
Overnight deposit is also a variant of interbank relations. The difference between overnight deposits and traditional ones is in the terms of provision. This is a short-term deposit for a day. As a rule, overnight deposits are deposits for large amounts. They are placed by financial organizations, large banks on the accounts of other banks. Overnight deposits are used in the interbank and money markets. The interest rate on overnight deposits is usually lower than on term deposits (we are talking about weekly terms and more). In order to contain inflation in a limited range, the Central Bank sets the amount of interest rates, including overnight. The current interest rate of the Central Bank for this type of deposit is reviewed every day and posted on the official website. Banks are forced to monitor this figure in order to adjust their internal overnight rate.
Overnight deposits for legal entities
This is a short-term deposit option, when the company places funds on deposit at the end of the working day, and in the morning the deposit amount, together with accrued interest, is returned to the settlement account. Thus, it is possible to place a deposit not only for the night, but also for a weekend and a holiday. Legal entities often resort to this service. Convenience is due to the fact that you do not need to withdraw money from the current turnover for a long time, and additional income can cover small and not very current expenses. This is also an excellent option for temporary "parking" of free funds on the account. To open a deposit overnight does not require additional paper procedures. If a company opens a bank account, then funds can be placed on an overnight deposit remotely via an Internet banking system. Simply, at the time of opening the overnight deposit, it is necessary to take care of the availability of a sufficient amount of funds on the current account. Speaking of the amount. Overnights are beneficial when placing large amounts, then even a small bet makes a profit. Overnight deposits are provided by all major banks. The conditions may be different. The same bank may offer a different interest rate, which will depend on the amount of the planned placement and the selected tariff. There are usually limits on the amount with which such a deposit can be opened.
Read more: How to evaluate growing companies? PEG Ratio
Overnight on the broker account
Each investor can receive additional income on their assets (securities, free funds) in a brokerage account if the overnight service is enabled. There are two views on this situation. Some recommend using this service and be sure to connect it with your broker if it is not enabled by default (it is better to clarify this point immediately, in order to avoid trouble). The investor will receive additional income, which is the ultimate goal of any investment! Others, in turn, strongly advise against using this tool, citing high risks. If the service is enabled (especially by default), then disable it. What to do here is up to you, of course. But in order to make decisions, you need to understand exactly what additional earning opportunities in percentages this service will bring, and what risks there are. We will analyze this with examples so that everyone can decide for themselves whether or not the "sheepskin dressing" is worth it.
The interest rate may vary from broker to broker. There are brokers who have absolutely no interest on this service. To find out for sure, it is better to ask your broker by calling the operator by phone, or ask a question in a chat by contacting the support service.
The most interesting thing is that the connected overnight is not a guarantee that the broker will charge you interest at all, especially every day. Interest will be accrued only when there is a real use of your assets, and this may not happen, because the broker usually needs "top" assets and in sufficient quantity to conduct such transactions.
While the investor is sleeping, the broker takes a security as collateral at the price set at the end of the trading day on the stock exchange, in return gives an obligation to return everything on time. In the morning, the broker returns the security and in addition pays interest for the use of the asset. All this happens without any unnecessary intervention on the part of the investor.
Independently, the broker does not have the right to use securities from investors' accounts. It is the consent to commit "overnight" that gives the broker the right to dispose of your shares, bonds and other securities. But why does a broker need this?
Securities may be needed by a broker in two cases:
- the broker can use this type of loan to secure some of his transactions (trading in the evening session, transactions with securities on international exchanges with depositary receipts for shares of companies, etc.).
- the broker lends securities to the trader to implement short-term strategies (such as "Short" transactions, for example).
That is, brokers are trying to "squeeze" the maximum yield from their assets and the assets of clients. Even at night, when investors are asleep, they make a profit.
Now about the benefits of overnight for the investor:
- Additional income for the broker's use of your securities (money) in debt. And it is this benefit that investors, and brokers themselves, put in the foreground ("money should work while you sleep"). But the benefit here is doubtful. If we compare it with one-day deposits for banks and legal entities, the difference is hundreds of percent (11-16% vs 0.05% per annum). At the same time, it should be understood that banks and companies place significant funds on deposits. To get at least a little noticeable amount (for example, to cover the amount of broker commissions), you need to have the amount of the most liquid shares in the account, estimated in millions of rubles. And even this is not a guarantee that the broker will use their entire amount. He will take them as needed.
- Additional bonuses for the connected "overnight" service. This is a kind of reward from the broker for the opportunity to use your assets when it is convenient for him. Your assets are "like a reserve" for him.
Read more: What is a PAMM account
Overnight risks for the investor
And now about the risks of overnight for investors.
- Lack of insurance. By themselves, investments in the stock market are not insured, unlike bank deposits. Insurance does not apply to transactions with the provision of free assets to the broker. Note that overnight deposit insurance is also absent in the banking sector, but there it is fully compensated by higher deposit rates and a guaranteed refund the next day.
- The absence of guarantees for the return of funds (assets and funds) to the original conditions of overnight. We remind you that when the overnight option is enabled, the broker can borrow securities from you and transfer them to a third party to implement some short-term strategy. And this third party is obliged to return the securities to the broker the next day so that he returns them to the investor again. This is an ideal situation. In case of default by a third party involved in the transaction, the money will most likely be refunded later. But at the same time, it is often prescribed in the terms of the brokers' tariff plans that the investor is not entitled to penalties and penalties. For an investor, this means the need for constant (or periodic) monitoring of the safety of funds in the account. Agree that this is extremely inconvenient for a long-term investor. And it may well turn out that if you go to sell shares one day, they will not be on the account.
- High risks of losing funds if there are problems with the broker.
There is an indisputable rule in investing: investments with high returns have a higher level of risk (the "Risk-return Concept"). Increased profitability is a kind of risk premium. In cases with overnight, this rule does not work for investors. The remuneration rates for the broker's use of free funds on the investor's account are less than 1%, and often they are hundredths of a percent. Not in a day, but in a year!!! This is a rate lower than the current percentage of the bank deposit and the most conservative investment option (in bonds). At the same time, in the conditions of the tariff policy, it is often prescribed that they can be unilaterally revised by the decision of the broker.
Whether to connect overnight or not is a matter of choice for each investor. But at the same time, regardless of the decision, it is important to understand all the risks of this option.
How to disable overnight
Let's say you still decided to disable overnight. Check whether this service was enabled initially (some brokers automatically include the terms of transactions in the overnight format in the contract when opening a brokerage account). There is a way to disable this function yourself in your personal account in the application or on the website. If this is not possible, then you can directly call your broker's hotline and ask them to turn off overnight.
Read more: What is the Overnight Interest Rate?
So, we looked at how the overnight service works. It is worth saying that in the banking sector, this is a really effective mechanism for profitable lending and placement of available funds. Based on the parameters of the service (short term and high rate), the characteristic "money works while you sleep" applies only to bank overnight. In the case of overnight on a brokerage account, there is no question of any real benefit and its guarantees. Hundredths of % for use, which may not be. The connected overnight service, unlike bank overnight, is only a permission to the broker to take your assets when he needs exactly the amount in which it will be needed. That is, the broker's lending service is absolutely opaque and, as real practice shows, unsafe.
Earning income is the main goal of investment activity. Depending on the investor's attitude to risk, it is possible to implement different strategies with different levels of profitability. Investors may think that overnight is a great way to earn extra money during the period when the exchanges are not working. But if you get into the meaning of the investment itself, it becomes clear that investment assets continue to work regardless of the time of day and day of the week:
- Shares are a share in a business, often in a large business that operates around the clock and does not suspend its work for weekends and holidays. There are a lot of examples – from metallurgists to companies in the retail sector.
- Bonds are a promissory note to a specific business. This business also continues to work in order to pay interest on the loan (coupons) to the investor on time and repay its debt (the nominal value of the paper) on time. Even on weekends and holidays, coupon income (the so-called NCD) continues to accumulate, which is paid to the investor in accordance with the schedule.
In search of additional sources of income, you should not neglect the basic safety rules.