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  • David Bojan

Money Market Funds: A Complete Guide

In this guide, we're giving you the full breakdown of money market funds including what they are, if they're safe, and their pros and cons. Read on.

Cash spread out in hands

What is a Money Market Fund?

Money market funds are a cash-like investment that enables investors to earn an income on their cash with minimal risk. Investors use them to park cash balances, perhaps temporarily whilst other higher-risk alternatives are considered, or longer-term to effectively reduce the overall risk level of a diversified investment portfolio.

Types of Money Market Funds 

The UK fund industry trade body, the Investment Association (IA), categorises money market funds into two types: short-term and standard-term funds. 

Short-term funds are lower risk. Fund managers try to ensure the highest possible level of safety by investing in very short-duration bonds and longer-term high-quality bonds in the fund portfolio.

Standard Money Market funds generally deliver slightly higher returns by owning bonds that have slightly longer maturity dates. 

Why Invest in Money Market Funds? 

They are a safe place to hold your cash, without having to use a traditional bank account. The return increases as interest rates rise. Moreover, Money Market funds tend to be cheap and easy to trade, making them a cost-effective tool for managing cash.

Man holding cash in hands

Advantages of a Money Market Fund 

  • Very low risk, likely to at least hold its value and pay out a modest income.

  • Diversified and highly liquid, meaning investors are not exposed to a single bond failing (within the fund) and investors can withdraw their money easily. 

  • Can be held in UK tax-friendly wrappers, like an ISA or SIPP.

Disadvantages of a Money Market Fund 

  • It's possible for a money market fund to fall in value, unlike a bank savings account, although unlikely.

  • Not suitable for growing savings over the long term as yields are typically below the inflation rate. 

  • Sensitive to interest rate fluctuations, with lower rates leading to lower yields. Yields rise when interest rates rise.

  • The Bank of England warns that in times of market panic and a rush to cash, there may be liquidity issues in Money Market funds.

Are Money Market Funds Safe?

There is no guarantee that the value of a fund won't fall, but they are managed by professional fund managers who aim to maintain their value. 

A Money Market fund is still an investment, even though it is low risk, and could go down in value. The Bonds held in the fund can fluctuate in value over time, and it is possible that a company may not be able to pay back its debt.

However, Money Market funds are diversified across many financial instruments and providers, so the risk of losing your money is low. They own high-quality bonds that are due to mature soon, meaning they are highly unlikely to default or struggle to pay their interest obligations.

Stock graph increasing

Why are Cash Returns on the Rise?

The Bank of England reduced interest rates to historic lows, first during the financial crisis of 2008-09, then at the start of the pandemic in 2020. 

In March 2020, rates were cut to a record low of 0.1% in response to Covid-19. However, in December 2021 the Bank of England began to rapidly increase interest rates to tackle inflation. This had the effect of increasing returns from cash.

What Will Happen if Interest Rates Keep Rising?

As interest rates rise, Money Market funds and some longer-term cash savings accounts are now offering reasonably attractive rates of interest.

What is the Rate of Return on a Money Market Fund? 

Yields on Money Market funds have risen lately as interest rates have increased. The yield figure on a fund reflects the amount of income the fund is generating from the underlying investments, at the time of writing around 5% in Sterling.

All in all, money market funds are an affordable way, low-risk way to manage your cash. If you're interested in learning more about them, speak to one of our advisors.

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