A money market fund is one of the least risky investment options available to investors seeking a stable return on their money in volatile times.
These funds invest in cash deposits, particular financial instruments (monetary contracts between two parties which can be traded) and high-quality bonds which pay a return that’s similar to holding your money in cash. They may appeal to investors who are seeking a safe haven for their stocks and shares ISA money during periods of economic uncertainty.
Here, we explain exactly how money market funds work, and what you need to know about them if you’re considering investing in one.
What is a money market fund?
A money market fund is a low-risk investment that can be held in a stocks and shares ISA wrapper. You don’t pay tax on investment returns received in a tax-efficient ISA. Read more about ISAs in our guide ISAs explained.
The return you receive on a money market fund generally rises or falls in line with movements in the Bank of England’s base rate, similar to cash savings accounts. Money market funds invest in a wide range of short-term fixed income securities or bonds that typically mature within less than six months. They are basically a type of debt that offer a fixed return from money lent to the government, banks or companies who need money. You can learn more about bonds in our guide What are bonds and how do they work?
This type of fund is generally considered to be even lower risk than UK government bonds, also known as gilts, which invest in government assets. By comparison, UK gilts often come with much longer maturity dates of several years at least, and therefore more potential for losses. You can find out about the different types of investments in our guide Investing – the basics.
Money market funds pay rates of return that are similar to cash accounts, or possibly slightly higher, depending on the particular assets they invest in.
Why invest in a money market fund?
Volatile stock markets and uncertain economic times can be very worrying for investors, especially for those approaching or in retirement who may not have decades to weather market storms. Money market funds can offer a relatively safe choice for your tax-efficient stocks and shares ISA, and could be considered a defensive core to a wider investment portfolio.
Money market funds can give you peace of mind that your money will hopefully be protected even in the event of a stock market crash. You may not have decided yet where you want to invest over the longer term, too, they can provide a useful short-term home for your money. Alternatively, you may be planning on spending this money within the next few years, and not want to invest for the long term. You can also withdraw your money if needed as you don’t need a long timeframe, unlike traditional stocks and shares.
Types of money market funds
There are two main types of money market funds, according to the Investment Association: short term, and standard term money market funds.
Short term money market funds are the most common type and work as explained by investing debt that’s considered particularly low risk. By contrast, standard term money market funds typically offer a slightly higher return by investing in bonds with slightly longer maturity terms. All money market funds are regulated and must offer high levels of liquidity by investing in relatively short-term assets.
Pros and cons of money market funds
As mentioned, the main advantage of a money market fund is that they are low-risk investments that can be held in an ISA. Your investment in a money market fund should remain roughly the same value as well as pay out some income. In addition, your fund will be spread across a variety of bonds that are highly liquid, which means you can usually withdraw your money when and as needed.
While unlikely, there’s a chance that your fund could fall in value as it’s still an investment, unlike a standard cash savings account (although the value of cash will be eroded over time by inflation). A money market fund also isn’t the best place to invest for long term growth over five years or longer. Money market funds have become more competitive in the rates they pay as the Bank of England hiked interest rates in the past year. However, whether they continue to pay a rising income will depend on what’s happening more widely to interest rates.
Are money market funds safe?
Unlike cash savings accounts, money market funds aren’t covered by the Financial Services Compensation Scheme (FSCS) which protects the first £85,000 held with a single institution.
As with any investment, the value of your pot could fall as well as rise. However, as money market funds hold a range of short-term high-quality bonds, the chances of losing your money are small. While bond prices vary, as those held are due to pay out soon, they are unlikely to default or fail during this timeframe. Read more in our article Are my savings safe?
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