What role can cash funds play in a portfolio?

Important information - the value of investments and the income from them, can go down as well as up, so you may get back less than you invest.

What role can cash funds play in a diversified portfolio?

It’s important to hold a mix of assets (such as cash, bonds and equities) as these different assets behave differently in the same economic conditions.  

Holding part of your portfolio in cash funds, can help reduce the effects of volatility if another asset class performs badly. This is particularly true when interest rates are high as they have been as they offer moderate returns for the level of risk an investor is taking.  

Why are cash funds so attractive right now?

At the moment, cash funds are offering quite attractive yields compared with recent history. These higher interest rates may make cash funds particularly appealing for investors who are at the more cautious end of the spectrum, as they can still generate relatively secure incomes without having to take much interest rate risk or credit risk. This is because cash fund yields generally follow the path of central bank interest rates.

Are cash funds the same as bank deposits?

No, they are different and it’s important to understand why. Any money you place in a bank deposit is secure. The bank may pay you interest (how much - and the terms - depends on bank, but there are still high-interest rates on offer with the Bank of England holding the interest rate in February at 5.25%).  

Explainer: Read our latest update about interest rates here.

A cash fund is an investment, so its value will fluctuate over time. It invests in a number of different instruments, so your money is invested in many issuers - spreading the risk you take.  

How can investing in a cash fund help me to be tax efficient? 

If you invest in a cash fund in an ISA or SIPP, any returns taken from your ISA are tax free, so it’s a tax-efficient way to save. Learn more about being tax efficient.

Are cash funds able to adapt quickly when interest rates move? 

With a cash fund, the fund manager is potentially able to slow how quickly the yield falls when interest rates to start to fall (although broadly speaking they’ll eventually reflect market conditions). They can control this by tweaking the underlying assets that the fund holds - as the maturity (or length of loan), the geography and the types of the underlying cash or cash-like assets can all affect the distribution yield of a cash fund.

Are there any downsides to cash funds?

Like any investment, returns aren't guaranteed. The yield on a cash fund largely follows the central bank base rate (even though fund managers can do certain things to control how quickly the distribution yield rate of their fund rises and falls).  

There are also associated fund charges attached to investing in a cash fund. So, you need to factor those in when investing in a cash fund. 

If you’re an investor with a longer-term time horizon, you might also like to consider that any returns from money market funds may possibly lag behind any returns that could be achieved from shares and bonds over more extended periods. Equally, as part of a diversified portfolio of investments, this relative ‘lag’ may be perfectly acceptable to those hoping to achieve a bit less volatility and a balance of risk and reward.

If interest rates start to fall, will cash funds still be worth holding? 

It’s always good to hold some cash in your portfolio so you have exposure to a range of assets classes. While it appears we're unlikely to go back to those very low rates that dominated the last ten years, these higher-for-longer interest rates may continue to present investors with an attractive income - especially for the risk they're taking.

Next steps 

There’s not long to go until the end of the tax year - midnight on 5 April. Your 2023/24 ISA allowance is £20,000 and it’s a tax-efficient way to save. So, it’s worth using up as much of it as you can as - unlike your SIPP allowance - you can’t carry it forward. Don’t let indecision stop you. As long as you move your money into your ISA or SIPP ahead of the deadline, it’ll count towards your allowance. You can always invest it later (and you’ll earn interest while it’s parked in your account). If you want it to work a little harder for you, you might like to think about investing in one of these lower-risk cash funds until you decide exactly what you want to do with it.  

One of Tom Stevenson’s fund picks for 2024 is the Fidelity Cash Fund. This is a very conservatively managed fund, with a focus on safety, liquidity and diversification, designed to deliver consistent returns. The distribution yield is currently just above 5%. 

If you’d like to know about all the cash-like funds we hold on our platform, I’ve listed them out below.

• abrdn Sterling Money Market Fund 
• BlackRock Cash Fund 
• Fidelity Cash Fund 
• Invesco Money Fund UK 
• Legal & General Cash Trust 
• Royal London Short Term Fixed Income 
• Royal London Short Term Fixed Income Enhanced 
• Royal London Short Term Money Market Fund 
• WS Canlife Sterling Liquidity Fund

And there are other routes to help make your cash work harder with us below.  

Learn: how you can make your cash work harder.