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Capital inflows into money market funds have soared in the past year as investors seek higher returns on their cash.
With yields above 5 percent, investors are turning to cash-like instruments to protect themselves from inflation eating into their cash.
Instead, May savers will put their cash into easy-access savings accounts, which offer similar returns.
Money market funds have become popular among investors looking to protect their cash for a short time.
But money market funds have emerged as an alternative for investors to put their cash into the short term.
With better returns than savings accounts, should you consider diving into money market fund investments? And how could the prospect of a rate cut affect profitability?
What are money market funds?
Money market funds, often described as cash bonds, invest in a selection of investments considered the safest available.
The Investment Association classifies money market funds into short-term funds and standard term funds.
Short-term funds tend to have lower risk, while standard funds tend to offer higher returns but have slightly longer maturity dates.
In terms of what they actually invest in, it is usually cash and cash-like instruments whose returns are linked to interest rates.
They also invest in short-term debt issued by governments and companies that are unlikely to default.
Its yields have become more competitive as interest rates have risen, reaching an average of 4.66 percent in 2023.
Its relatively low risk profile has also increased demand. Last year, money market funds had their best year on record, with inflows exceeding the last eight years combined, according to Calastone’s Fund Flow Index.
Is it a better option than a savings account?
Money market funds are considered relatively low risk but, like any investment, their value could still fall.
While this is rare, it’s worth considering if you’re weighing money market funds versus a savings account.
Savings account rates are still quite generous: the best easy access savings account currently offers 3.12 per cent, according to Moneyfacts, while an easy access Isa rate is 3.31 per cent.
You can check the best offers in our savings tables.
So why do investors opt for money market funds instead of putting their cash in a savings account?
The two are very different. Cash funds are mainly used for a short period, rather than a long-term investment.
Investors usually put their money there if they don’t want to get out of the stock market completely.
Laith Khalaf, head of investment analysis at AJ Bell, says: “For those who want to earn a return on the cash they are waiting to invest, and investors who need to keep some cash-like assets in their portfolio, such as withdrawal investors , Money market funds have become increasingly popular.’
Keeping cash in a money market fund, within your stocks and shares Isa, also makes it much easier to switch between funds.
“If you want to move from one cash account to another because rates have changed, this usually means moving banks with all the hassle that entails,” adds Khalaf.
“Money market funds are slightly riskier than cash accounts, but they have a long history of stable, safe valuations, with extremely low levels of volatility.”
That said, there is a risk that money market funds could face liquidity if too many investors rush to withdraw their money at once.
Darius McDermott, CEO of FundCalibre, says cash funds are “not a bad temporary option” for people who like to dip in and out of funds.
‘For most people, it will be easier to stick with an easy-to-access savings account. You’re unlikely to get much more return on money market funds than the current base rate, and investors should be aware of the fees involved (typically around 25 basis points).’
Jason Hollands, CEO of Bestinvest, says he has seen increased interest in money market funds on the platform, “although it has been more of an uptick than a torrent.”
He adds: “However, in general, most clients who want a short-term home to park their subscriptions choose to hold cash, as the current interest rate paid by our custodian is an attractive 4.45 per cent and there are no account fees for this. .’
Other platforms also offer interest on uninvested cash held in an Isa, although this is usually much lower than that of a savings account.
AJ Bell offers 2.52 per cent on up to £10,000 in an Isa, rising to 3.55 per cent above £100,000, while Hargreaves Lansdown offers 2.2 per cent.
Interactive Investor offers 2 per cent on the first £10,000, rising to 2.75 per cent between £10,000.01 and £100,000 and 3.75 per cent between £100,000.01 and £1 million sterling.
Will cash funds be attractive after rate cuts?
Money market fund returns are affected by interest rate movements and expected changes.
While earning good returns isn’t the only reason to hold money market funds, some investors might reconsider their portfolio weighting.
“This means that if rates were to fall in the second half of the year, money market yields would also fall. However, if rates rise or remain stable, yields will remain high,” says Sam Benstead, head of fixed income at Interactive Investor.
‘But as the Bank of England is only likely to cut rates once or twice this year, the impact on yields should be relatively small. If inflation continues to fall, then real (inflation-adjusted) yields may actually rise even if overall yields fall.’
McDermott is less convinced, saying, “If rate cuts eventually happen, you probably don’t want to be in cash,” because yields will fall.
Instead, he advises investors to look for longer-term bonds, which guarantee higher returns for longer, or real estate investment trusts (REITs).
‘If you have a higher risk appetite, consider UK small caps. For REIT exposure, TR Property Investment Trust is a solid choice, while for UK small caps we currently prefer IFSL Marlborough UK Micro Cap Growth and Liontrust UK Micro Cap.’
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