Savers looking to earn a return on their cash traditionally opt for an easy-access savings account. These accounts are highly-liquid, meaning they offer quick access to the funds when you need them. If you’re unsure of your investment time horizon or have a low risk tolerance, they make sense.
But a lesser-known alternative is rapidly gaining popularity among this group of savers: money market funds (MMFs). Like savings accounts, they're highly liquid, provide short-term access to your cash, can be held in an ISA, and carry a very low level of risk.
Both can offer returns on your funds, but there are some key differences which we'll go through in this article.
Table of contents:
1. What is a money market fund?
2. How safe are money market funds compared to savings accounts?
3. What interest rates are available?
4. How easily can I access my money?
5. What is your investment horizon?
6. Are MMFs right for you??
2. How safe are money market funds compared to savings accounts?
3. What interest rates are available?
4. How easily can I access my money?
5. What is your investment horizon?
6. Are MMFs right for you??
1. What is a money market fund?
A money market fund is a type of mutual fund that invests in short-term high-quality securities, cash and cash equivalents — and is required to maintain a high level of liquidity. The yield you earn on MMFs is variable and can change daily. Traditionally these funds have a high minimum investment requirement and were inaccessible to many savers, but brokers including Lightyear let you invest as little as £1 / €1 / $1.
A key difference from a savings account is that money market funds are not insured by the Financial Service Compensation Scheme (FSCS) or the EU's Deposit Guarantee Schemes Directive, as they’re technically investments into the stock market. That said, MMFs are generally considered to be among the lowest risk investments you can make; money is kept in funds that invest in highly diversified, first-tier instruments from the world’s biggest banks. The likelihood that they’ll go down in value is very small, but as with all investments, your capital is at risk.
Let's say a large and reputable company, Cyberdyne Systems, needs some quick cash for a few months. Instead of going to a bank, they issue short-term IOUs called commercial paper. The money market fund steps in and buys the IOUs from Cyberdyne using the pooled money from investors (like you). Since Cyberdyne is reliable and the loan is short-term, it's less risky.
As an investor in the money market fund, you're indirectly funding Cyberdyne's short-term debt. When Cyberdyne pays back the loan with interest, that profit becomes part of the fund's earnings. You get a piece of those earnings based on your investment.
2. How safe are money market funds compared to savings accounts?
Investors in money market funds typically face minimal risk due to the conservative nature of the fund's investments, as holdings have short maturity. They tend to offer a higher interest rate than ordinary savings accounts, so if you’re looking to capitalise on central bank interest rate rises and earn a higher return, MMFs could be a smart choice. Their popularity has recently increased due to the continuous rate hikes, as their performance is closely tied to the interest rates set by the ECB.
You can invest in money market funds through Lightyear Vaults – these give access to three BlackRock money market funds in USD, GBP & EUR. All BlackRock funds offered are AAA rated - the highest rating possible - with a risk/reward profile rating of 1/7, the safest. The underlying assets of these funds have a very high level of capital security.
While considered an extremely low risk investment option, MMFs are still not as secure as traditional easy-access savings accounts, which benefit from FCSC protection. So for individuals with a very low risk tolerance and who are willing to accept a lower interest rate, a savings account may be a better choice.
3. What interest rates are available?
While money market funds typically offer higher returns than savings accounts, they’re not entirely immune to fluctuations in interest rates. In the broader context of financial considerations, money market funds are exceptionally low-risk and boast high liquidity. So if your primary goal is to pursue yield above all other factors, these funds might represent the most favourable option. Investors should be aware of management fees and expenses associated with these funds, as they can impact overall returns.
Lightyear is one of the few investment platforms giving low-cost access to BlackRock money market funds, with its high interest Vaults offering up to 5.36% AER (variable rate, as of 18.07.24).
By contrast, savings accounts typically offer lower interest rates compared to money market funds, often dipping below the inflation rate. Additionally, many of these accounts feature a fixed interest rate, making them particularly susceptible to challenges in inflationary environments where prices and expenses experience an uptick. However, they often come with fewer fees, making them a straightforward option for individuals looking for a no-frills approach to savings.
4. How easily can I access my money?
One of the key features of money market funds is their high level of liquidity. Investors can typically redeem their shares at any time, making it easy to access funds in times of need. This liquidity feature is especially beneficial for those who may require quick access to their capital.
Savings accounts also offer liquidity, allowing account holders to withdraw funds as needed. However, some accounts may have restrictions or penalties for frequent withdrawals - looking for an ‘easy access’ account, and not a fixed term investment, is one way to avoid this. Because of these restrictions, investors who need quick access to their cash must take care to view the terms and conditions of the specific account.
5. What is your investment horizon?
In this section we’ll look at how money market funds and savings accounts might work for different investment scenarios. Please note that this is not investment advice, so do consult a professional if you’re looking for this!
Money market funds are well-suited for short-term investment goals or as a temporary parking place for funds that will be needed in the near future. Let’s say you’re saving for a holiday, and anticipate that you’ll need the cash at short notice within the next 6 months:
- You can’t accept a high-level of risk, because you know you’ll need the cash soon,
- You can’t lock away your money, because you plan to book your holiday as soon as a deal is available or prices look favourable,
- You’re not seeking a high-level of growth from your cash, and instead are simply looking to earn interest to offset inflation before you book.
In this scenario, a money market fund could be the ideal place to park your cash. They provide a safe and liquid option for investors who prioritise capital preservation over long-term growth. For savers with a longer time horizon and higher risk tolerance, a different investment approach - such as a mixture of ETFs and MMFs - may be more suitable.
What about savings accounts? These accounts are versatile, and can accommodate both short-term and long-term savings goals if you’re willing to lock away your cash. Committing to a fixed term - such as 12 or even 24 months - may enable you to lock-in a higher interest rate, which could be ideal for savers with extremely low risk tolerance but longer term investment horizons.
If you’re unwilling to accept even the lowest level of risk, or cannot get access to a money market fund through your bank or broker, then a traditional savings account may be the best option for earning interest on your cash. It certainly beats letting your money languish as cash, losing value due to inflation!
Conclusion: are MMFs right for you?
Choosing between a money market fund and a savings account depends on your financial goals, risk tolerance, and time horizon. By considering the questions and scenarios we’ve explored on this page, you can make an informed decision that aligns with your financial needs. Whether you prioritise liquidity, risk management, or maximising returns, understanding the nuances of these financial instruments is essential for building a robust and tailored financial strategy.
Disclaimer
When investing, your capital is at risk.
Paula is a Communications Specialist at Lightyear, sharing news about the platform across the media and investor communities with a focus on Hungary, Spain, Portugal and Germany. She’s worked in marketing and communications across a variety of sectors over four years, and ran her own marketing agency for the better part of two years.
