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Looking for a short-term alternative to traditional cash savings? You're not alone. Money market funds have surged in popularity recently, largely thanks to higher interest rates boosting their returns. They provide a way for individuals to access the money markets – traditionally the domain of governments and large corporations seeking low-risk, short-term homes for large sums.
Now, with the government considering cutting how much you can pay into cash ISAs, using a money market fund within a stocks and shares ISA is gaining appeal as a way for individuals to hold cash-like balances.
You might be considering how to hold cash within your ISA or pension, need a temporary home for money before making your next move – or simply want a low-risk alternative to a savings account.
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Money markets are a collection of short-dated, low-risk investments designed to provide returns slightly higher than typical cash savings.
They are usually high-quality investments with a low chance of the borrower defaulting on their debt (because they will mature soon – in under a year, often much less – and are from issuers with a high credit rating). So, you invest your money and in return for the slightly higher risk than keeping it in cash savings, you usually get a marginally better return.
Typically, money market investments are:
If you want to invest in the money markets, then you do so via a money market fund.
Ed Monk, associate director at the wealth manager Fidelity International, says that money market funds have jumped to the top of the best-seller fund charts in the past two years, thanks mainly to the rise in interest rates that has boosted the returns they offer.
A money market fund is a type of low-risk investment that aims to offer slightly better returns than a typical cash savings account. It does this by investing in a combination of short-term debt, such as government bonds, corporate bonds and certificates of deposit.
“Their purpose is to give a return after fees that’s slightly higher than what you can get from cash in the bank,” says Hal Cook, senior investment analyst at Hargreaves Lansdown.
Unlike many other investments, the underlying assets in money market funds are short-dated – meaning they mature in a matter of months rather than years. This allows the fund manager to forecast expected returns more accurately.
Although these funds are considered low risk as investments go, they are not without risk. Cook says: “The reason these funds should give you a higher return is because they’re riskier than just holding cash. That said, the investments that make up these funds are usually high quality with good credit ratings, meaning the probability of default is low. However, unlike cash at the bank, there’ll be times when money market funds lose value.”
This can happen if, for example, interest rates rise sharply and temporarily hit the value of short-term bonds. Over time, those bonds typically recover as they near maturity, but there are no guarantees.
If you’re new to investing, read our guide on how to choose the right type of investments for you.
There are various money market funds available to UK investors. They’re usually on sale labelled ‘money market fund’, ‘short-term money market fund’, ‘money fund’, ‘sterling liquidity fund’ or ‘sterling money market’.
Different funds will have varying specific holdings, objectives, and charges, so always read the Key Investor Information Document (KIID) or factsheet before investing.
You typically buy them from an investment platform, potentially within the wrapper of a stocks and shares ISA if you want to make sure your returns are tax-free.
Read more about how to choose an investment platform.
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There are three key differences between a money market fund and a savings account.
Although they are considered low risk compared to other investments like shares, money market funds are not risk-free.
When you invest, your money goes into a variety of short-term bonds and similar instruments issued by governments and corporations. While these are typically high quality, there is a small chance that an issuer could default, reducing the fund’s value.
The main risk is default of the bond issuer. However, the potential for default should be very low given the very short periods of time that each investment has in these funds before they mature.
“A manager investing in a bond with only two months to maturity, will usually be able to tell whether the issuer will be able to pay the terms of that bond. But shocks can, and do, happen,” adds Cook.
Money market funds can be useful as you approach retirement, as they offer a way to protect your capital while still earning a modest return.
They can also appeal if your pension provider doesn’t allow uninvested cash, or if you want to temporarily hold cash within your ISA or SIPP while deciding on your next investment, rather than withdrawing cash which could affect your allowances or tax status.
However, if you are well into retirement and rely on this capital for immediate living expenses or emergency access, the small risk of short-term value fluctuations might outweigh the potential for slightly higher returns compared to easily accessible, FSCS-protected cash savings.
“It’s possible that simply having cash in the bank makes more sense,” adds Cook. “While the returns are typically a bit higher for money market funds than savings rates on cash, the risk of potential short-term falls needs to be considered. With the purpose of cash in retirement likely to either be for day-to-day spending or for emergencies, removing any risk of unexpected losses makes sense”.
Money market funds aren’t designed to make you rich. But they can be a way to manage short-term cash needs, or a strategy for reducing your exposure to market volatility as you approach retirement.
The government is said to be considering reducing cash ISA contributions, potentially from £20,000 to just £4,000 a year. If that does happen, money market funds held within a stocks and shares ISA could become a more common strategy for savers wanting to shelter cash-like holdings from tax.
Many of us are looking for low-risk ways to keep our money working without locking it away. A money market fund could be the solution, if you understand the risks.
As with any investment decision, it’s worth speaking to a financial adviser or doing your own research if you’re unsure whether a money market fund is right for you.
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