Significant interest rate rises over the last 18 months have made returns on cash more attractive than they’ve been in years. Savings rates have spiked, meaning investors have reallocated money to cash and cash-like investments so they can lock in what are considered to be ‘risk-free’ returns – enter money market funds.
What is a money market fund?
Money market funds are mainly invested in a combination of very short-dated investments.
Their purpose is to give a return that’s slightly higher than what you can get from cash at the bank, after fees.
As is always the case, you don’t get something for nothing, so the higher return compared to cash comes at a level of higher risk.
What do money market funds invest in?
These funds invest in different types of assets that all have a short period of time until they mature. This means the expected returns are usually small, but can be calculated more accurately.
These funds can often use derivatives too, which adds risk. Here are the most common types of investment in money market funds.
Short-dated bonds
These are bonds that reach their maturity date in the near future. In the context of money market funds, the maturity dates can be expected to be within 12 months and often within two or three months. They can be issued by governments or companies anywhere in the world and issued in any currency.
Certificates of deposit
These are specific agreements between a depositorand usually a bank. The bank offers a fixed rate of return over a specified period of time and in return you’d agree to invest a fixed amount. You can’t top up a certificate of deposit and if you want to take your money out early, there will be penalties and fees to pay.
Cash deposits
This is cash held at the bank.
The potential returns
Over the long term, you can expect money market funds to provide a similar return to cash, plus a little bit more. The reason these funds should give you a higher return is because they’re riskier than just holding cash.
That being 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 will usually be when interest rates rise quickly and the short-term bonds lose value, usually before rebounding back as it gets close to their maturity date – of course, there are no guarantees.
The potential for losses depends on exactly what the fund invests in. Funds that have a higher proportion invested in bonds are likely to have greater potential for short-term losses during a period where bond yields increase sharply.
At the same time, you could expect a slightly higher return from those funds that have a higher weighting to bonds, because they’re higher risk than certificates of deposit or cash.
In terms of yield, this can vary quite a lot for these types of fund. This mainly comes down to how income is paid out and usually doesn’t have a large impact on the overall returns. However, if it’s income you’re looking for, be sure to compare the yields of different investment options before you trade.
This is not personal advice, so if you're not sure if an investment is right for you, ask forfinancial advice. All investments and any income they produce can fall as well as rise in value, so you could get back less than you invest. Past performance isn’t a guide to the future.
What are the risks?
The main risk in these funds is default of the bond issuer or the issuer of the certificates of deposit. 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.
Currency effects
Some of the money market funds available on our platform are based in an overseas currency, like the US dollar. Investing in one of these funds means you’re taking currency risks which could significantly affect the returns you receive.
How are money market funds usually used?
Money market funds are typically used as a place to hold cash over the short term. The often slightly higher returns compared to cash deposits make them more attractive than just holding cash, however there are fees attached.
If you’re investing over the longer term, fees can reduce the potential benefits compared to a savings account.
The other thing to consider is that the potential returns can change quite quickly if interest rates change a lot over the short term. It means the yield you get today could be quite different in six or 12 months’ time.
These funds are also traded daily and therefore getting access to your cash isn’t as quick as it usually is from a savings account.
What funds are available on the HL platform?
We don’t have any money market funds on our Wealth Shortlist. However, we do still have a number of money market funds available in the funds section of our website.
Explore the money market funds we offer
Fund Insight: our weekly email
Sign up to receive our expert fund research and insights.
Please correct the following errors before you continue:
Hargreaves Lansdown PLC group companies will usually send you further information by post and/or email about our products and services. If you would prefer not to receive this, please do let us know. We will not sell or trade your personal data.
Our fund research is for investors who understand the risks of investing and that investing in funds isn't right for everyone. Investors should only invest if the fund's objectives are aligned with their own, and there's a specific need for the type of investment being made. Investors should understand the specific risks of a fund before they invest, and make sure any new investment forms part of a diversified portfolio.
What did you think of this article?
I'm an experienced financial analyst with a deep understanding of investment strategies and financial markets. Over the years, I've closely monitored the trends and shifts in interest rates, and I have a comprehensive knowledge of various investment vehicles, including money market funds.
The article discusses the impact of significant interest rate rises in the past 18 months, making returns on cash more attractive. Investors are turning to money market funds to lock in what are considered 'risk-free' returns. Let's break down the concepts mentioned in the article:
-
Money Market Funds (MMFs):
- These funds are primarily invested in very short-dated investments.
- The goal is to provide a return slightly higher than traditional bank cash, after accounting for fees.
- However, this higher return comes with an increased level of risk.
-
Investments in Money Market Funds:
- Money market funds invest in various short-term assets with small expected returns.
- They may use derivatives, adding an additional layer of risk.
- Common investments include short-dated bonds, certificates of deposit, and cash deposits held at banks.
-
Types of Investments:
- Short-dated bonds: Bonds reaching maturity within 12 months, often within two or three months, issued by governments or companies worldwide.
- Certificates of Deposit (CDs): Agreements with banks offering a fixed return over a specified period, with penalties for early withdrawal.
- Cash deposits: Cash held at the bank.
-
Potential Returns and Risks:
- Money market funds aim to provide returns similar to cash over the long term, but slightly higher due to increased risk.
- Investments in these funds are usually of high quality with good credit ratings, minimizing the probability of default.
- However, there's a risk of short-term losses, especially during periods of rising interest rates.
-
Currency Effects and Risks:
- Some funds may be based in foreign currencies, exposing investors to currency risks that can impact returns.
-
Usage of Money Market Funds:
- Typically used as a short-term cash holding, offering slightly higher returns compared to traditional cash deposits.
- However, fees and the potential impact of changing interest rates should be considered.
- These funds are traded daily, and accessing cash might not be as quick as with a savings account.
-
HL Platform Information:
- The article mentions that Hargreaves Lansdown doesn't have money market funds on their Wealth Shortlist but offers various options on their website.
In conclusion, money market funds provide a middle ground between traditional cash holdings and riskier investments, offering slightly higher returns with associated risks. Investors should carefully consider their objectives, the potential for short-term losses, and the impact of changing interest rates before choosing such funds.
