If you’re looking for a low-risk home for your savings, options include a money market fund held in an ISA or a cash ISA.
Both may appeal to savers who are seeking a safe haven for money in difficult economic times. However, while money market funds and cash ISAs have some similarities, they are in fact quite different in how they work, and the best option for you will depend on your current circumstances and attitude to risk.
In this article, we’ll explain how both these financial products work and the main differences between them.
What is a money market fund?
A money market fund is a low-risk investment that invests in short-term fixed income securities or bonds that can be held in a stocks and shares ISA wrapper.
They may appeal if you want a relatively safe investment option that should weather economic uncertainty.
While many other types of funds involve investing in dozens of company shares, money market funds typically focus on short-term debt, such as company and government bonds. The investments usually mature within about six months, so pay out relatively quickly.
What is a cash ISA?
A cash Individual Savings Account, or ISA, is a unique type of tax-efficient savings account. You can pay in a certain amount of money each tax year and pay no tax on any interest earned. In the 2023/24 tax year, your ISA annual allowance is £20,000, and you can either invest this full amount in a cash ISA, or put it into a stocks and shares ISA or an innovative finance ISA, or you can split your allowance between different types of ISA.
Cash ISAs are similar to standard savings accounts offered by banks and building societies.
However, the tax benefits of cash ISAs can mean that the interest rates on offer are sometimes less generous than rates paid by standard savings accounts. Whether or not it’s worth saving into a cash ISA depends on how much you have saved elsewhere. Everyone has a Personal Savings Allowance which entitles basic-rate taxpayers to earn £1,000 in interest a year on their savings outside an ISA free of tax, and higher-rate taxpayers to earn £500. Additional rate taxpayers don’t get a Personal Savings Allowance.
You can learn more in our guides What is the Personal Savings Allowance and ISAs explained.
What are the differences between a money market fund and a cash ISA?
Tax benefits
A cash ISA enables you to earn interest on your savings without worrying about being liable for any tax on this money. If you hold a money market fund outside an ISA, you may be liable for tax on your returns. However, it is possible to hold a money market fund in a stocks and shares ISA, and any returns you make will be tax-free. Read more about stocks and shares ISAs in our article How do stocks and shares ISAs work?
Alternatively, you can invest in a money market fund through a SIPP (Self-Invested Personal Pension), which comes with its own tax advantages. You can learn more in our article Everything you need to know about SIPPs.
Investment vs cash account
Money market funds and cash ISAs are fundamentally different as the former is an investment, while the latter is simply a cash savings account. There is no risk of losing capital when you put your money in a cash ISA, because it is not being invested anywhere. If your provider goes bust, your money is protected by the Financial Services Compensation Scheme (FSCS) up to a maximum of £85,000.
On the other hand, though money market funds are considered one of the lowest risk investment options, they are not without risk. As with any kind of investment, it is still possible to end up with less than you put in, although there’s less uncertainty with a money market fund as the timeframes involved are short. Money market funds are often popular with investors who want to use their stocks and shares ISA allowance, and want somewhere to keep their cash until they’ve made up their mind.
How much you can pay in
While you can only pay up to your total £20,000 annual allowance into ISAs each tax year, you can invest as much as you like into a money market fund outside an ISA.
However, if you invest in a money market fund via a stocks and shares ISA, the amount you can pay in is also subject to the £20,000 limit.
Interest rates and inflation
In general, money market funds aim to pay a slightly higher return on your savings than you’d receive in a cash savings account, such as a cash ISA or standard savings account. However, whether this is the case will depend on the particular account you choose. You can find the best cash ISAs on the market at the moment with our article Best cash ISA rates – which cash ISAs pay the most interest?
Remember that your savings are still subject to inflation, which erodes the value of your money over time. In a high inflation environment, your savings in both cash ISAs and money market funds may not keep pace with the rising cost of living.
Should I save into a cash ISA or a money market fund?
Ultimately, whether you get a cash ISA or a money market fund will depend on your personal preferences and financial situation. While both are low-risk savings products, it’s important to understand their differences before deciding on the right option for you. You can find out more about how money market funds work in our guide ‘What is a money market fund?’