8th April 2025 11:32
by Sam Benstead from interactive investor
Central bank interest rate rises mean that investors can finally get a good return on their cash.
In the UK, the Bank of England base rate is now 4.5%. Interest rates peaked at 5.25% but are beginning to fall as inflation has dropped back near the central bank 2% target. Some economists think that UK interest rates could end 2025 at around 4%, but a lot will depend on inflation figures.
Investors have a number of options. While they could buy UK government bonds (gilts), which yield between 4% and 5%, they could also stray into the corporate bond market, where yields are even higher. However, bond prices can be very volatile, and investors could be hit with capital losses even if the income is stable.
Savings accounts are another option, but yields tend to lag bond market equivalents. Moreover, unless the account is inside a cash ISA, where returns are lower, savers may have to pay tax on their returns.
Basic-rate taxpayers (up to £50,270 annual income) get a £1,000 tax-free savings allowance, while higher-rate taxpayers (up to £125,140 annual income) get £500 and additional rate taxpayers (earning more than £125,140) get nothing. Any savings interest above the thresholds is taxed at income tax rates.
Money market funds could fit the bill
Money market funds are a viable in-between option, offering the income similar to gilts maturing soon, but without the complexity, while also mitigating the risk of bond price fluctuations. They can be held inside ISAs and SIPPs.
They own a diversified basket of safe bonds that are due to mature soon, normally within just a couple of months, meaning that investors can earn an income on their cash with minimal risk. They can also put money into bank deposit accounts and take advantage of other “money market” instruments offered by financial institutions.
On our platform, assets in money market funds have risen 1,100% (a 12-fold increase) in the past two years.
Fund industry trade body the Investment Association (IA) categorises money market funds into two buckets: short-term and standard-term funds.
Short-term funds are lower risk. Fund managers try to ensure the highest possible level of safety by keeping very short duration bonds and high-quality bonds in the portfolio.
Standard money market funds generally deliver slightly higher returns by owning bonds that have slightly longer maturity dates. There are also less stringent liquidity requirements.
| Fund | Ongoing charges figure (%) | Yield (%) | Fund size (£million) |
| Royal London Short Term Money Market | 0.1 | 4.53 | 7,489 |
| L&G Cash Trust | 0.15 | 4.5 | 3,251 |
| Fidelity Cash | 0.15 | 4.54 | 1,937 |
| BlackRock Cash | 0.2 | 4.54 | 973 |
| Vanguard Sterling Short Term Money Market | 0.12 | 4.93 | 1,400 |
Source: FE Analytics/ latest data published as of 8 April 2025. Past performance is not a guide to future performance.
| Fund | Ongoing charges figure (%) | Yield (%) | Fund size (£million) |
| Premier Miton UK Money Market | 0.26 | 4.4 | 330 |
| Invesco Money (UK) No Trail | 0.15 | 4.38 | 116 |
| abrdn Sterling Money Market | 0.15 | 4.7 | 835 |
Source: FE Analytics/ latest data published as of 8 April 2025. Past performance is not a guide to future performance.
Investors usually have a choice between an accumulation (acc) or income (inc) version of a fund, which determines whether income is automatically reinvested or paid out as cash.
Dzmitry Lipski, head of funds research at interactive investor, says: “Royal London Short Term Money Market stands out most to us in the sector. It has an excellent long-term track record, low drawdowns and is competitively priced with a yearly ongoing charge of 0.10%.
“The fund seeks to maximise income by investing in high-quality, short-dated cash instruments. The managers place particular emphasis on the security of the counterparties it lends to, while ensuring daily liquidity.”
The interest paid by money market funds will fluctuate with bond market yields, which are closely linked to central bank interest rates. This means it will rise when yields rise, but fall when yields fall. As interest rates are expected to keep dropping this year and next, yields on money markets are also likely to drop.
Advantages of a money market fund
- Very low risk, with the portfolio likely to at least hold its value and also pay out a modest income
- Diversified, meaning investors are not exposed to a single bond failing and can withdraw their money easily
- Can be held in a tax-friendly wrapper, such as an ISA or SIPP.
Disadvantages of a money market fund
- Investments may fall in value, unlike savings accounts
- Not suitable for growing savings over the long term as inflation will eat into returns
- 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.
It’s interesting to see how central bank interest rate changes are impacting investors and savers. The shift from peak rates to a potential 4% by the end of 2025 shows how closely tied everything is to inflation. I’m curious, though, how much of a difference the tax-free savings allowance really makes for basic-rate taxpayers compared to higher earners. The rise in money market funds is impressive, but I wonder if the average investor fully understands the risks and benefits of short-term versus standard-term funds. Do you think the current focus on safety in short-term funds might limit potential returns too much? Also, with the choice between accumulation and income funds, how do most investors decide which is better for their goals? It feels like there’s a lot to consider, and I’d love to hear more about how people are navigating these options.