What Are Money Market Funds In The UK? 

Investing goes far beyond just stocks. In fact, there are plenty of investment options, each appropriate for different types of people and circumstances. 

One example is money market funds. They have generated quite the buzz in recent months as one of the safest investments in the UK and have proven numerous times to be an excellent option for short-term money goals. 

In this article, we’ll explain what money market funds are, their pros and cons, and the potential risks of investing in money market funds in the UK.

Pros 

• Lower risk compared to other funds
• Minimum investment risk and a better return
• Suitable for short-term active investors

Cons

• Sensitive to rate fluctuations
• No investments protection
• No long-term investment goal

What are money market funds? 

Money market funds are mutual funds that invest in a high-quality bank, government, or corporate debt. They are relatively low-risk funds with very liquid short-term investments in high-quality instruments, like money market securities, cash or cash equivalents, that are distributed in dividends. 

Money market funds are sponsored by investment fund companies. They are not FDIC insured, similar to how investing on stocks are, which means that you may not receive your investment back since there’s no guarantee of principal.

How do money market funds work? 

Money market funds are limited to investing in government bonds and commercial paper mainly because they are low risk. The securities reach their peak in around one year when investors can (and should) get their returns.

What should I consider when investing in money market funds? 

Money market funds are the perfect investment tool for investors looking for a short-term investment. What’s more, stock market volatility doesn’t affect money market fund investments as much as other investment options, making it suitable for more risk-averse investors. 

The investments in the money market funds can also be diversified. Spreading your money across different companies can minimise the risk of losing all of the invested capital if one company fails.

The downside is it can be a challenge to get good return rates.

Types of money market funds

Money market funds are classified based on the maturity period, class of invested assets, and other attributes. The most popular types of money market funds include:

Government money funds

In this type of market fund, 99.5% or more of the assets are invested in very liquid investments, such as cash, repurchase agreements, and government securities. They are all collateralized with government securities or cash. 

Treasury funds

These funds invest primarily or exclusively in US government debt, including treasury bills, bonds, and notes. 

Prime money funds

A prime money fund invests in commercial paper of non-treasury assets issued by government agencies and corporations. 

Tax-exempt money funds

As the name suggests, this type of market fund allows investors to earn low interests without having to pay taxes on it.

Types of Money Market Instruments

There are several types of money market instruments, including:

Commercial Paper (CPS)

Commercial papers, which are issued by companies and institutions, are unsecured instruments with a high credit rating. They are promissory notes issued at a discount rate and redeemed at face value.

Government bonds (Gilts) 

Government bonds are investment vehicles that provide fixed rates of return until they expire. If you’re looking for risk-free, opt for government bonds. 

Certificate of Deposit 

Timed deposits are similar to fixed deposits offered by commercial banks. The main difference between them is that you can not withdraw any Certificate of Deposit until maturity.

Repurchase Agreements (Repos)

Repos allow one firm to sell a security to another firm with a promise to repurchase it later at a specified price. The main difference between the repurchase price and the sale of the deposit is in the interest rate.

What are the risks of investing in money market funds?

Money market funds are considered to be on the low end of the spectrum in terms of risk. However, they aren’t risk-free.

The biggest risk that comes with all types of investment funds is losing the money you’ve invested. For example, the share price usually remains at £1, but it can decline, which can be detrimental to your investment. 

The rates also vary. They might increase by the name you’re supposed to get a return on your investment, but there’s always a possibility that you can lose your investment if the investment value drops.

Then there’s inflation, which can plummet some or all of your investments. 

Finally, money market funds are not UK-regulated savings and aren’t backed by the Financial Services Compensation Scheme. If the company you’ve invested in fails, you will not get your money back.

Why use a money market fund? 

As previously mentioned, money market funds are considered low risk in the world of investing. There is a limited risk associated with it, compared to the risk of investing in stocks, which, unlike money market funds, have higher returns.

Liquidity is also a key factor when it comes to money market funds. Investors in these funds can quickly turn their profits into cash. The sales of the fund often take place on a trading day, and it can take only a couple of minutes to transfer the funds to your spending account. 

What’s more, money market fund investors also get both dividend advantage and easy cash access. Some institutions allow writing checks so investors can withdraw money. The only thing they should worry about is fees or restrictions that the institution might impose.

Furthermore, money market rates are pretty responsive in the UK. You can always keep an eye on when the rates are rising or are on the low.

Money Market Fund vs Savings Account

Saving accounts are a good equivalent for people who don’t want to take the risk of investing in a money market fund. Saving accounts have fixed-rate bonds and come with a guaranteed interest rate. ISAs have been the most common type of savings account in the UK.

How is a savings account safer than a money market fund investment? There’s no risk of losing the money. If you open a savings account, you will get a return on your investment. It’s a risk-free way of earning passive income, though the rates are pretty low, ranging from 0.25% and 0.5%.

Bottom Line 

If you’re looking to invest your money in high-quality, short-term debt, then money market funds are the way to go. Unlike stocks, money market funds aren’t as risky, are high in liquidity, and are short-term money goals.