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.

Markets expect that interest rates will fall at some point this year, but when that might take place is still uncertain. In fact, at the start of the month the Bank of England held the interest rate at 5.25% for the fourth time in a row - stating that rate cuts will have to wait until there’s firm evidence that inflation is under control (which doesn’t bode well as inflation held steady in January at 4%, not the news the government wanted).

High interest rates make things more challenging for borrowers but can be very beneficial for savers. And it’s one of the reasons why cash funds have proved so popular with both ISA and SIPP investors on our platform both last year and this.

So, exactly what role can cash funds play in a portfolio?

What is a cash fund?

A cash fund tends to invest in a portfolio of short-term cash deposits, money market instruments and high-quality bonds (to be absolutely sure what assets the cash fund holds, you should always check the fund factsheet). And it’s designed to provide a high level of stability and liquidity for investors looking for a modest investment return at the lower end of the risk spectrum.

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.

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

Learn: how you can make your cash work harder.  

Important information - investors should note that the views expressed may no longer be current and may have already been acted upon. An investment in a money market fund is different from an investment in deposits, as the principal invested in a money market fund is capable of fluctuation. Fidelity's money market funds do not rely on external support for guaranteeing the liquidity of the money market funds or stabilising the NAV per unit or share. An investment in a money market fund is not guaranteed. The value of shares may be adversely affected by insolvency or other financial difficulties affecting any institution in which the Fund's cash has been deposited. There is a risk that the issuers of bonds may not be able to repay the money they have borrowed or make interest payments. When interest rates rise, bonds may fall in value. Rising interest rates may cause the value of your investment to fall. Tax treatment depends on individual circumstances and all tax rules may change in the future. Withdrawals from a pension product will not be possible until you reach age 55 (57 from 2028). This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to one of Fidelity’s advisers or an authorised financial adviser of your choice.

Latest articles

Is now the time to invest in the UK?

The case for investing in the UK

Graham Smith

Graham Smith

Investment writer

The 150-year-old investment trust that’s a best-seller

An internationally diversified portfolio aiming for growth

Nick Sudbury

Nick Sudbury

Investment writer

Retire early? Forget ‘FIRE’ and follow ‘CHILL’

Financial independence at all costs may not be worth it

Andrew Oxlade

Andrew Oxlade

Fidelity International