Three years ago this weekend I began to write on Monevator about the new coronavirus, which by late February had gotten the attention of the markets:
Things were definitely feeling freaky by the fourth day of 3-4% declines.
When the US market bounced higher into the close on Friday – perhaps on the expectation that central banks will make some sort of statement about interest rate cuts this weekend – you could almost feel the relief, even though all the main indices still ended the day in the red.
UK government bonds, for the record, are up.
Unstoppable
Just in case you’ve been living in a bunker – which is where we’ll all be in a few weeks, according to some – the cause is the novel coronavirus.
COVID-19, as we groupies have started to call it.
Together with a few geeky friends I’d monitored Covid’s spread via then-obscure health sites and academic services since Christmas. I already had my mother self-isolating. And during a rare meeting with The Accumulator on the first Sunday of February, I’d shocked him by revealing I’d sold a huge portion of my portfolio and was even holding gold.
That all sounds very smart and prescient. But the fuller story is far more muddled.
For starters I’d bought back a lot of my equities just two to three weeks later!
The market wasn’t crashing, you see, and it’s usually right. I started thinking that maybe @TA was correct that this virus could prove to be just another localized SARS-type outbreak.
Notes from Underground
Unlike many people, I’ve a written record here on the blog – especially in the comments – of my thoughts over the weeks and months that followed.
This reminds me what I believed as our understanding of the virus evolved. As opposed to what I wish I did!
It’s a good check on hindsight bias and selective memory.
Some things I was ahead on, such as the long-term disruption caused by repeated lockdowns. I’d argue the way things played out also vindicated an early belief that we should overwhelmingly concentrate on protecting the oldest people. I was right too to get optimistic about shares again as soon as late March, when the fiscal spigots opened. And I correctly favoured technology firms.
But other stuff I got very wrong.
In retrospect I couldn’t get my head around the virus being a dial-shifting issue for years. I kept looking for signs of a speedy resolution – maybe as soon as the end of 2020. My efforts at being an amateur epidemiologist did afford me moments of insight.
But overall I would have done better just to listen to the pros. Although many of them were, like me, too optimistic about the ability of vaccination to halt transmission.
The Plague
Anyway all these debates played out in the comments on this website – and that itself was interesting too.
In the early days we had a free and open debate. Regular commentators took varied views, but I’d say there was mostly an understanding that there were open questions and we were all feeling our way in the face of something personally unprecedented.
But after just a few months some sort of crystalizing took place. Positions hardened. Politics entered the picture in a big way. And like most things in our benighted political times, what began as a health issue became a binary them-and-us stand-off.
At the least I shuffled across one side of that line too.
Being and Nothingness
My aim in recalling all this is definitely not to do any sort of finally reckoning as to who was right about what – let alone who ‘won’ the pandemic.
Too many are doing that now, especially in the US.
The worst of them are almost willfully dismissing or forgetting just how uncertain and afraid we collectively were in those early months of 2020, as we watched hospitals overflowing with the dying from the enforced confines of our own homes.
And it’s rather that which I want to recall.
Trivially, the time has come to remove my ‘Covid Corner’ as a regular section in the Weekend Reading links.
The virus is endemic. And though some would say the pandemic isn’t over, 60 seconds on any High Street shows that nearly everyone who can do so has moved on.
But it’s more what that crisis confronted us with that I want to put a pin in today – before we trundle into the next furore.
Because it’s rare to see your world turned upside down in a matter of weeks as happened in March 2020.
Even if you’ve come to see the lockdowns as a sort of pleasant holiday from reality, say, the fact is that for a period the authorities compelled you and most people you know to stay at home, while at the same time going out could conceivably get you killed.
Normally a country needs to go to war for such existential disruption. Sadly Ukrainians have had a double-dose of it in the past year, but if we’re lucky many of the older among us may never face such a period again.
I think it’s worth some intentional archiving.
Waiting for Godot
For myself, I want to store away the feeling of uncertainty. The spectrum of fear. The collapse into tribalism. The strangeness of shopping and swerving among the other masked figures. The oscillating emotions towards those who broke the rules. The groping for answers.
The specter that seemed to stalk us.
The debates about this or that policy will continue for a while. But in time they will become accepted truisms, depending on how you lean. Like the Thatcher government’s response to the Miners’ Strikes or US involvement in Vietnam.
The nuance will be forgotten. Yet even now scientists can’t convincingly decide if masks made a meaningful difference to transmission, for example.
It’s nuance all the way down.
I’ll end with some great lines from Yeats. I’ve always liked the sound of them. But the past seven or eight years have also shown me the truth of them:
Turning and turning in the widening gyre
The falcon cannot hear the falconer;
Things fall apart; the centre cannot hold;
Mere anarchy is loosed upon the world,
The blood-dimmed tide is loosed, and everywhere
The ceremony of innocence is drowned;
The best lack all conviction, while the worst
Are full of passionate intensity.
Never waste a good crisis, say the politicians. They mean the chance to bury bad news or to take tough decisions.
But I’d hope a crisis might also teach us to be a little wiser too.
Have a great weekend – and let’s enjoy our freedom to do so.
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Can you believe it? My own sister uttering the dreaded words:
“I am just throwing money away by renting.”
Ouch! That’s up there with “renting is dead money”.
She might as well have added, “You Only Live Once!” and then spent her ISA savings on a YOLO tattoo.
Before we begin: I’ve learned that it’s impossible to write about UK property without provoking an outburst of emotion – from every faction – so a quick nod to the laundry list:
Yes, people want to own homes for different reasons.
Yes, at the end of 25 years of renting, you’re still renting.
Yes, mortgage rates may go up / go down / do the Hokey Cokey.
But that is not what I’m talking about today.
What I’m questioning is the idea that renting is inherently wasteful and that having a mortgage is inherently productive.
Let’s unpack this to see why my sister has compounded the damage she did by watching The Water Babies on VHS 20,000 times and then crying and claiming I hit her when I tried to make it stop.
Renting is: paying for something valuable
First off, renting is nothing like throwing money away.
When you throw money away, then – unless you’re Robin Hood, Brewster, or in fear of St. Peter – you get nothing back.
In contrast, when you give money to your landlord, you get somewhere to sleep, eat, make whoopee, and write investing blogs.
Here is Maslow’s famous hierarchy of needs:
Hint: the big ones are at the bottom. (Click to enlarge)
Maslow rightly understood that ‘shelter’ was crucial to human beings. We tend to freeze, rot, dry out, get eaten by animals, or are plagued by packs of foreign exchange students without it.
In fact, Maslow stated shelter was as important as sex, food, and air – but maybe not in that order.
(In the modern world, you don’t get much sex without shelter. Although to be fair you will then get more than your fair share of air.)
Housing, in short, is a basic human need. This is what your landlord gives you in exchange for rent. An essential of life! Maybe my sister should send her landlord a thank you card, rather than a dismissal?
But what about home ownership? Is that essential?
Sadly, Maslow didn’t tell us where “ability to hammer a nail into own wall’ or “opportunity to take part in house price bragging” fitted into his pyramid. He lived in simpler times.
My hunch is – daytime property porn be damned – that Maslow would consider such things to be self-actualization, topping the pyramid alongside philosophy, ballet, and drinking mint juleps.
What is a mortgage in legal terms?
A mortgage is a loan used to buy property. It’s an agreement between you and a lender that involves the latter loaning you the money you need to buy a property (or else a way of raising money against the value of a property you already own).
When you take out a mortgage, you agree with your lender to pay it back the capital you borrow – plus any interest accrued – over some prearranged period of time – typically 25 years – and at an agreed interest rate.
The interest rate you’re charged may vary with market rates (a so-called variable rate mortgage) or more commonly be fixed for some years.
In the UK, fixed-rate mortgages typically run for two to five years. After that period you’ll go onto the lender’s variable rate mortgage, unless you take out a new fixed-rate deal.
Other types of mortgages are available. For instance, a discount mortgage varies with your lenders’ variable rate. But a discount is applied so you pay a little less.
Note that in the UK1 interest rates will fluctuate over the lifetime of your mortgage.
This means that when any fixed-rate mortgage or other deals expire – or on an even more regular basis with a variable rate mortgage – your borrowing costs will be recalculated. Hence your monthly payments will vary.
When do you clear the mortgage?
Most home buyers take out a repayment mortgage. Here the total borrowing cost – including interest – is calculated at the start of the arrangement. You steadily pay the interest and repay the principle via a schedule of monthly payments.
Interest-only mortgages are also available. These are particular popular when buying investment properties. With an interest-only mortgage you only pay the interest over the term of the mortgage. You pledge to repay all the capital at the end of the term (say 25 years).
Most repayment and interest-only mortgage agreements do allow you to make payments in excess of what was initially agreed, however. These extra payments can dramatically reduce how long it takes you to fully pay off the loan, and hence the total cost of borrowing.
Play with our mortgage calculator to see how you can reduce the cost of your mortgage. (It’s as close as it comes to getting exciting about a mortgage.)
Finally and crucially, note that a mortgage is a secured loan. It is backed by the value of the property you buy with it.
Putting up your home as collateral like this makes a mortgage much less costly than other personal loans. But the quid pro quo is that the mortgage agreement gives the lender the right to seize your property if you fail to keep up with your payments.
A mortgage is money rented off a bank
So far, so conventional. You take out a mortgage to buy a property in exchange for a monthly bill – and the risk of losing your home if you don’t keep up with your payment schedule.
However I believe it’s helpful to think a bit deeper about what a mortgage really is. Like this we can exorcise some of the dogma of home buying.
Because despite that aforementioned fabulous need-solving you achieve by renting, most people still aspire to swap paying the monthly rent for a new life as a mortgage-shackled wage slave.
When you buy a house with a mortgage, the bank gives you money, as discussed.
Let’s say it gives you £200,000.
Party time! (I’m assuming hedonism for you is 30 days and nights on Rightmove.)
Once the initial euphoria of home hunting is over, a new mortgage owner begins the slog of paying the darn thing off.
And it turns out – obviously – that the bank didn’t give you £200,000 for nothing. As we’ve discussed it wants interest on the mortgage.
It’s as if it leased you the money. You’re paying to rent the money off the bank.
At 5% over 25 years, borrowing £200,000 will cost you £833 a month in ‘money rent’
You have swapped rent payments to your landlord for rent payments to your bank.
Note again that if you only ever pay your ‘money rent’ and nothing else, then you must give back the £200,000 borrowed at the end of the mortgage term.
Just like you have to hand back a rented house to your landlord!
To avoid this – and to keep your home – then you must repay the capital also.
Effectively, with a repayment mortgage you’re buying £200,000 in cash off the bank, in monthly installments.
With a 5% mortgage rate over 25-year repayment mortgage deal, you’d need to pay an additional £350 every month to ‘buy’ your £200,000 off the bank.
You might even think of a mortgage as a cash savings account that starts £200,000 in the red. With a repayment mortgage, you’re salting away £350 a month. After 25 years, the balance is £0.
Happy days!
Equally, if you can rent your home for less than you’d pay to buy, then you could choose to save the difference. You might even save up £200,000 that way.
Note: I’ve oversimplified here. As already flagged up, monthly repayments are in reality variable over the mortgage term as they fluctuate in some fashion with interest rates.2 Capital payments are a smaller share of the monthly bill at the start but predominate at the end, as your previous repayments reduce the interest due. Again, check out the graphs via the Monevatormortgage calculator.
Only money under a mattress is dead money
Of course no bank these days will lease you £200,000 without some security.
The bank tries to protect itself twice.
Firstly it demands a deposit of at least 5%, but frequently much more.
Secondly there’s that inconvenient fact that it can repossess your house should you fail to repay the money you borrowed (/rented) off it.
Let’s say my sister has had enough of ‘throwing money away’ and wants to buy a flat for £500,000.
She’ll likely need at least £25,000 as a deposit – and I’d strongly urge her to aim for £50,000 or more – in order to appease the bank’s money landlord.
Of course, you have to give a deposit to a property landlord to rent their house, too.
But when I last rented a place, I put down one month’s rent – or only about 0.25% of that property’s market value at the time. Bargain!
The opportunity cost of a mortgage deposit
As interest rates on cash have recovered, the situation has become even starker. Today, my sister’s would-be deposit cash is only dead money if she keeps her savings under a mattress.
I can think of little worse than looking under my sister’s mattress, but I’m sure there’s no money under there.
Instead, my sister has her money in savings accounts, bonds, and the stock market.
Even if she simply puts her would-be house deposit cash into a super-safe fixed-rate savings account, she can currently earn 4% or more.
That’s hardly dead money.
By the same token, it’s not dead money if the cash is used to get a mortgage.
If you’re paying a mortgage rate of 5%, then your deposit is effectively in the equivalent of a savings account paying 5% interest, tax-free.
That’s nice, too.
Again, I am not saying one arrangement is inherently better or worse than the other. I am saying these decisions have more in common than you might think.
The deal when you pay rent
Buying a house basically involves:
Deposit + interest payments + (usually) capital repayments + other costs (legal fees, taxes, new boilers, renovations, and so on) + the gain or loss in house prices
Both private owners and landlords also get an income from leasing out their property.
As a home owner you get the better deal, since you rent it out to yourself, tax-free3, whereas a landlord leases it to a third-party tenant who might not pay and who won’t clean the gutters. Worse, her rental income is liable for tax.
In contrast, as a rental tenant your landlord handles most of the faff for you.
Renting simply involves:
Monthly rent + a month’s deposit
Whereas the deal for the landlord looks something like:
(Everything listed for a private homeowner above) + void risk4 + rent payment risk5 + some landlord-specific costs + income tax + (likely) capital gains tax
Your landlord also takes on risks on your behalf. There’s the risk that house prices will go down for starters, as well as the risk that interest rates will go up.
Of course landlords do all this in expectations of making a profit over time. I expect house prices will rise over 25 years, and rents too. But there’s no timetable – and it’s still a risk.
So a landlord deals with a lot of faff, takes risks, and satisfies a key human need.
That’s quite the deal you get for “throwing money away” by renting a home instead of buying.
You decide if it is a good time to rent money
Once more with feeling: none of this is to say that it’s not a good time to buy a property, or vice-versa, or to rent, or vice-versa.
When I wrote the first version of this article in 2013, house prices seemed very expensive to me, especially in London.
Luckily, I noted back then that I’d been wrong about prices for a decade. And now another decade has passed and prices are even higher again! But they’re apparently wobbling…
So who knows.
What I was confident about, however, was that borrowing was cheap in 2013.
We saw money get even cheaper to rent for many years after that – as low as 1%!
The cost of money eventually did rise quite a bit in 2022, however, as the Bank of England hiked interest rates. Mortgage rates spiked further in October 2022 with the Mini Budget farrago.
But rates have since come down again. Indeed it’s interesting to see people (not me!) predicting 40% price falls when five-year fixes are available at 4%, given that ten years ago money already seemed very cheap with fixes not vastly lower at 3%.
Of course the difference today compared to 2013 is even-higher house prices.
Property prices have grown far faster than wages have increased, too.
Which way will you rent?
Sadly, banks will only rent money cheaply to most of us to buy homes, and homes seem expensive. There’s the rub.
But the point is: renting a home isn’t throwing away money. It’s paying for a service.
And a mortgage isn’t free. You pay to rent money.
It amuses me that the conventional thinkers who say renting is dead money are also often the same people who say paying off their mortgage was the best feeling they ever had.
Make your mind up! Do you like renting money or not?
Note: Original article updated in February 2023, so comments below pondering what is a mortgage and/or the meaning of life may be out-of-date. On the other hand this stuff is pretty timeless. See you in 2033, across a rubble-strewn landscape and so on!
Unlike the US where you typically lock in a mortgage rate for the entire term when you buy. [↩]
Whereas, for example, dividing £200,000 by 25 years worth of monthly payments is £666 a month. [↩]
It is called imputed rent. Please don’t complain to me, follow the previous link if you want to learn more. [↩]
A money market fund (MMF) is an open-ended investment fund that holds short-term debt issued by governments, banks, and large corporations. MMFs play an integral role in the global financial system as pools of short-term funding for organisations such as governments, pension funds, insurers, companies, local authorities, and charities.
Money market funds have also acquired a secondary function as a cash reserve for ordinary ‘retail’ investors (that’s us!) chasing a better rate of interest than they can get from a bank account or cash ISA.
But is the higher yield potential of a MMF worth the extra risk that comes with them? We’ll aim to answer that question – and more – in this guide.
What are the main investment objectives of money market funds?
The primary investment aims of money market funds are:
Stability
Daily liquidity
Credit risk diversification
Returns aligned to the prevailing money market rate
Because MMFs are relatively stable investments they’ve been marketed to ordinary investors as ‘cash equivalent’ products.
However while money market funds are low volatility, their extra yield does come with additional risk strings attached.
Moreover, those risks are most likely to materialise during a period of heightened market stress, when ready access to cash is paramount.
Are money market funds considered to be cash?
Money market funds should not be thought of as cash. The Financial Conduct Authority (FCA) makes this point crystal clear in its Resilience of Money Market Funds paper:
As an investment, MMFs do not guarantee principal, and the investor must bear the risk of loss. MMF investments are equity liabilities, unlike bank deposits which are debt liabilities whose value is supported by equity capital.
It is true that money market funds are low-risk in comparison to equities and bonds.
But MMFs are riskier than cash because:
They offer same-day redemptions to their investors
But the majority of their assets are less liquid than cash and may not be immediately sold
This means there’s the potential for a liquidity mismatch if too many MMF investors make a ‘dash for cash’ during a market shock.
Under extreme conditions, money market funds can struggle to meet investors’ demands for their money back. That is exactly what happened during the Global Financial Crisis and the Covid crash.
It’s an extra dimension of risk for investors who think of their money market fund as a cashpoint.
What’s inside a money market fund?
It becomes obvious that money market funds aren’t just cash when we look at the list of financial instruments they typically invest in:
Commercial paper (unsecured, short-term corporate debt)
Corporate and sovereign floating and fixed-rate bonds
UK Treasury bills (ultra short-term government debt)
Repurchase and reverse repurchase agreements (short-term borrowing and lending in government securities via the repo market)
Bank certificates of deposits (CDs)
Cash deposits
This chart shows the break down of assets held by GBP money market funds:
Money market funds do pay interest, but the rate is variable and not guaranteed. You won’t see an annual interest rate attached to a money market fund as if it were a bank account.
Typically, GBP money market fund interest payments resemble the Sterling Overnight Index Average rate known as SONIA.
The benchmark SONIA rate is supervised by the Bank of England. It is aligned to the overnight borrowing costs of banks.
You can check out the latest SONIA rate for yourself.
The next chart shows how SONIA has risen in the past year. Interest rate fans should notice that SONIA is closely tethered to the UK’s official Bank Rate:
Source: Bank of England.
Estimating money market fund interest rates
We can use SONIA to approximate the annual rate of interest available from a GBP money market fund.
However, SONIA can only ever be a rough guide to MMF income payments because:
SONIA fluctuates daily
Payouts from a money market fund are net of fees
So we must deduct all our investment fees from SONIA as part of our interest rate estimate.
For example, let’s say today’s SONIA rate is 3.92%.
From that you would deduct your following investment costs:
The MMF’s Ongoing Charge Figure (OCF) – e.g. 0.11%
Transaction costs (the fund’s underlying transaction costs, applicable spreads, and your broker’s dealing fees, if any.) – e.g. 0.01%
Your broker’s platform fee – e.g. 0.25%
Your potential money market fund interest rate is thus:
3.92% – 0.37% = 3.55%
Money market funds are actively managed so some may beat SONIA periodically, or even over long periods of time. That’s hard to gauge with reasonable certainty, and isn’t guaranteed. Personally, I’d treat anything extra as a bonus.
Comparing your estimated money market fund interest rate against a bank account
Pop your estimated money market fund interest rate into a compound interest calculator such as this one. Match your inputs to the calculator’s fields like this:
Initial investment = £1
Interest rate = 3.55% yearly (or whatever is your estimated MMF annual interest rate)
Years = 1 (this ensures the calculator gives us an annual compound interest rate)
Compound interval = Daily
Effective Annual Rate = 3.614%
The calculator’s Effective Annual Rate is the figure to compare against the Annual Equivalent Rate (AER) touted by your bank account. It gives us an apple-to-apples compound interest comparison.
Both rates assume you reinvest your interest throughout the holding period.
However you won’t get exactly this rate if you hold your money market fund for a year. Your MMF may not track SONIA perfectly. And SONIA varies daily in any case.
But at least this calculation provides a way of estimating if a money market fund offers any kind of interest rate advantage over a bank account.
Other money market fund yields
On a money market fund’s webpage you may see a percentage rate called something like ‘dividend yield’, or ‘net yield’, or ’12-month trailing yield’, or similar.
Such yields are typically calculated by summing up the last year’s worth of interest paid divided by the fund’s current price or Net Asset Value (NAV).
If interest rates are rising then a trailing yield will probably underestimate your near-term income from the fund.
If interest rates are on a downward trend then a trailing yield is likely to overestimate your expected income.
This assumes that your principal remains absolutely stable. We’ll explain why you can’t take that assumption to the bank shortly.
Note: your interest is automatically reinvested if you choose an accumulation fund.
An income money market fund will pay out interest at the frequency indicated on the fund’s webpage.
Are money market funds taxable?
Yes, any interest or excess reportable income earned is taxable at your marginal rate of income tax as per normal cash savings.
Money market funds will often describe their income distributions as dividends. However they are taxed as interest.
There’s no tax to pay if you hold your money market fund in a stocks and shares ISA, or pension.
Your Personal Savings Allowance might also shield your MMF interest payments earned outside tax shelters from tax, depending on how much you have saved.
The Personal Savings Allowance enables non-taxpayers and basic rate taxpayers to earn £1,000 of interest tax-free. The amount is £500 for higher-rate taxpayers.
Low earners may be eligible to earn another £5,000 in tax-free interest using the little-known starting rate for savings.
Does your money market fund pay interest gross or net?
If your money market fund is registered as an OEIC or Unit Trust then check if it pays interest gross or net.
If interest is paid net then you’ll receive it with 20% income tax already deducted.
So a basic-rate taxpayer has no more to pay. (Yay!)
A higher-rate taxpayer owes another 20%
A non-taxpayer is due 20% back (Double yay!)
This is only an issue if you’re holding the fund outside of an ISA or pension. It’s also not relevant if your fund pays interest gross – that is, with no tax already deducted.
Scan the fund’s webpage or other documentation for the info. Or contact the fund manager directly for clarification.
If you invest in a foreign-domiciled money market fund then check its webpage or factsheet to ensure it has UK reporting fund status. If not, then any CGT liability must be paid at your income tax rate.
Money market funds tucked safely inside an ISA or pension are exempt from CGT.
Can money market funds lose money?
Money market funds can lose money. They typically invest in low-risk assets and are subject to close regulation. But you’re still not guaranteed to get back all the money you invested.
The clearest warnings come from the money market fund managers themselves.
Capital at Risk. The value of investments and the income from them can fall as well as rise and are not guaranteed. Investors may not get back the amount originally invested.
A Money Market Fund (MMF) is not a guaranteed investment vehicle. An investment in MMFs is different from an investment in deposits; the principal invested in an MMF is capable of fluctuation and the risk of loss of the principal is to be borne by the investor.
BlackRock goes on to list some of the risks that money market funds are exposed to:
Loss of Capital: an automatic share redemption may occur which will reduce the number of shares held by each investor. This share redemption will result in a loss of capital to investors.
Counterparty Risk: The insolvency of any institutions providing services such as safekeeping of assets or acting as counterparty to derivatives or other instruments, may expose the Fund to financial loss.
Credit Risk: The issuer of a financial asset held within the Fund may not pay income or repay capital to the Fund when due.
These risks are not merely theoretical. A huge and reputable US money market fund called the Reserve Primary Fund faced a run on its assets during the Global Financial Crisis in 2008.
Reserve Primary suspended redemptions and was eventually forced to liquidate its assets at a loss that impacted its investors.
The lessons of the Global Financial Crisis led to widespread reform of the $4.8 trillion money market industry both in the US and in Europe.
The MMF sector was again severely tested at the height of the Covid crash. Major institutional investors pulled their money as they scrambled to solve their own liquidity problems.
Money market funds subsequently faced massive redemption demands. And these were amplified by the unintended consequences of the previous round of reforms.
Fortunately, central bank action alleviated the pressure. Another wave of reform is now underway.
Cash crunch
The significant takeaway for ordinary investors is that – despite successive attempts by global regulators to strengthen money market fund resilience – what seems to be a low-risk vehicle in normal times can become unstable in extreme conditions.
The fact is that money market funds are not primarily designed to serve the needs of ordinary investors.
And the two most recent global crises illustrate that adverse feedback loops could restrict your access to cash at the worst possible time.
“Help! My money market fund is losing money” false alarm
If you do invest in a money market fund and you see an apparent capital loss shortly thereafter, check that you’re not being misled by the fund’s standard dividend payment operating procedure.
The following chart shows what looks like a repeating cycle of gains and losses by the Vanguard Sterling Short-Term Money Market Fund.
However, these share price fluctuations are just the regular monthly accumulation and distribution of interest from an MMF:
Every month, the fund’s net asset value (NAV) rises above its £1 par value due to the accumulation of interest paid into the fund from its assets.
That accumulating interest temporarily fattens the fund’s value before it is distributed to investors.
The fund falls in value on its ex-dividend date. That’s when the interest payments are set aside by the management team in preparation for payment to shareholders.
Hence the apparent loss is entirely compensated for by the income you receive from the fund on its distribution date.
This cycle repeats as the money market fund continually harvests and pays out interest.
Note that despite the dramatic scale of peaks and troughs on the chart, the differences in NAV amount to a tenth of a penny on the pound.
(With all that said, your investment would be much more volatile if you held a MMF in a foreign currency as you’ll then be exposed to the gyrations of the FX market, too.)
Are money market funds safe?
Money market funds are not as safe as cash. The additional risk inherent in their operation subjects them to pressures and rules that don’t apply to a simple bank account product.
The Financial Stability Board (FSB) spells out the two main MMF vulnerabilities in its 2021 reportPolicy Proposals to Enhance Money Market Fund Resilience:
“They are susceptible to sudden and disruptive redemptions”
“They may face challenges in selling assets, particularly under stressed conditions”
A wide range of large financial institutions use money market funds for cash management.
But some money market fund holdings have relatively limited liquidity, especially when markets are stressed.
This means that MMFs cannot guarantee daily redemption under all circumstances.
The cost of liquidating harder-to-shift assets can rise during a market slump, or dry up completely. This creates an incentive for some money market funds and their investors to redeem early in a crisis – before the cost of doing so increases, or the regulations impose firebreaks on selling.
The FSB comments that:
Taken together, these features can contribute to a first-mover advantage for redeeming investors in a stress event and thus make individual MMFs, or even the entire MMF sector, susceptible to runs.
The FCA spell out how this contagion spread during the Covid Crash:
In March 2020, financial markets reacted to the unexpected effect on economic activity of the Covid pandemic and the public health measures introduced to contain its spread. This shock exposed underlying vulnerabilities in the financial system, which catalysed an abrupt and extreme dash for cash. As a result, financial markets experienced increased selling pressure, volatility and illiquidity.
MMFs also came under severe strain across major currencies, including in sterling, as investors quickly sought access to cash. Investors redeemed their units in MMFs to make necessary payments elsewhere, such as margin payments.
However, some investors may also have redeemed or made additional redemptions partly due to fear of being unable to redeem at a future date.
Some MMFs struggled to maintain the required liquidity levels as set out in law and regulations, which increased the perceived (and actual) risk of funds being suspended, which in turn may have increased investor outflows from some MMFs.
I think that conclusively answers the question: “Are money market funds safe?”
UK and European regulation can impose the following penalties on MMF redemptions:
Additional liquidity fees
Restrictions on the amount you can withdraw (known as ‘gating’)
Suspending the fund
A low-risk MMF must transform to a riskier type if it’s suspended for more than 15 days within a 90-day period
These penalties could make life more difficult for an ordinary investor who needs cash in a hurry.
As citizens, however, we should be reassured to see such measures that aim to protect the wider financial system from the systematic vulnerabilities of MMFs.
Money market fund classification
There are four types of money market fund available in the UK and Europe.
From the most conservative type to the least, they are:
Public Debt Constant Net Asset Value (PDCNAV) MMFs
99.5% of assets must be invested in public sector debt issued by central government, local authorities, and quasi-governmental bodies.
Investors are able to buy and sell at a constant NAV price of £1 calculated to two decimal places. Volatility should be minimal under normal circumstances.
Low Volatility Net Asset Value (LVNAV) MMFs
Can invest in private debt as well as public sector securities.
Otherwise, liquidity requirements are as stringent as those that apply to PDCNAVs.
The fund’s price is maintained at a constant £1 NAV under normal circumstances.
Short-term Variable Net Asset Value (STVNAV) MMFs
Liquidity rules are looser than with the first two MMF types.
Pricing is variable, meaning capital gains and losses are possible under normal circumstances.
Standard Variable Net Asset Value (VNAV) MMFs
The least restricted money market fund type.
Enjoys the wider liquidity bounds of a STVNAV but adds longer maturity assets to the mix.
Variable pricing.
The FCA produced this table summarising the liquidity and maturity restrictions governing the four different money market fund types:
DLA = Daily liquid assets – the percentage of assets that can be disposed of in 24 hours
WLA = Weekly liquid assets – as above but disposal is allowed within a week
WAM = Weighted average maturity – the average time taken before the fund’s current holdings will be repaid by their issuer
WAL = Weighted average life – the average time taken before the fund’s holdings will repay the amount invested. Similar to Macaulay duration for bond funds
Risk is all relative
Compared to the differences between, say, equity funds, all MMFs are so conservative that it’s like comparing four Mrs Thatcher clones by the colour of their headscarves.
However, the FCA draws out this key distinction:
As noted, evidence from major MMF domicile jurisdictions strongly suggests that in a large-scale market stress, private sector-backed MMFs suffer large outflows, while public debt backed MMFs receive large inflows. LVNAV MMFs invest predominately in private sector assets, while the PDCNAV must invest almost entirely (minimum 95.5%) in public sector assets. The evidence also indicates that public sector debt markets are less likely to become seriously illiquid in large market stresses than private sector debt markets.
Your money market fund provider may mention what type it is on the product’s webpage or somewhere within its documentation. (Burying the info somewhere within a 200-page prospectus is a favourite wheeze. World’s. Worst. Word search.)
Does the FSCS compensation scheme apply to money market funds?
If a money market fund provider defaulted then you’d be entitled to a maximum payout of £85,000 per authorised firm – including their sub-brands. Sadly, the restrictions of the FSCS compensation scheme means that limit is the most you’re entitled to. That’s regardless of how many investment funds you own from that provider. The £85,000 does not apply per fund.
Moreover, the FSCS scheme does not cover investments – including money market funds – that are domiciled outside the UK.
If you own investments in Ireland or Luxembourg then you’re subject to the statutory compensation scheme followed by those countries. This limits compensation payments to a meager €20,000.
Best money market funds
You can buy and sell money market funds from investment brokers like any other fund.
Not every broker makes it easy to find MMFs on their platform, however. Your best bet is to drop the name of your favourite money market fund into your broker’s search bar.
But how do you compare money market funds in the first place?
For money market ETFs, use justETF’s ETF screener switched to the money market category.
There’s only a handful of prospects. You can easily compare them using justETF’s tools.
Note that some of the products are synthetic ETFs that use a financial derivative called a total return swap to match the SONIA rate.
For a broader trawl, go to Morningstar’s Fund Screener.
Flip the screener’s Morningstar Category to GBP Money Market – Short Term or GBP Money Market.
Long-term performance – Morningstar show up to 10-year annualised returns where available
Fees – Money market funds are typically actively managed and costs vary a great deal
Assets under management – big is beautiful
12-month yield – to gauge how generous previous interest payments have been
MMF classification – this will require a deeper burrow into the fund documentation
Still want a money market fund?
The pros of a money market fund are typically advertised as:
More diversified than cash in bank
May offer juicier interest rates
No early withdrawal penalties (not entirely true as we’ve seen)
Yet having done the spadework on money market funds I can’t imagine why I’d choose one over a decent instant access savings account, except where tax comes into the equation and for some reason you don’t want to use a cash ISA.
There’s another narrow use case for someone who wants to earn a little more on cash that would otherwise be parked in a SIPP at derisory rates.
But I can’t see that the extra smidge of interest is worth it versus the additional risks you’re running with a money market fund.
If you want the simplicity and safety of cash then put your money in a bank.
Will house prices fall, steady, or crash? I’d say a decline was the consensus view as we closed the door on 2022, with memories of Liz Truss still swirling about the porch like a frightful CGI spirit.
Yet having competent technocrats back in Downing Street after a multi-year hiatus has had such a calming effect on markets that the prospect of a proper slump seems to me to be abating fast.
PM Sunak and chancellor Hunt still can’t offer much in the way of growth. And that’s a problem in the long-term.
But even the slow puncture Brexit economy doesn’t seem quite so bad after October’s multi-lane pile-up.
Choose your poison
The major reason that if we’re going to economic hell in 2023 it’s on a Stannah Stairlift not a handcart is lower mortgage rates.
Declining swap rates had suggested there was room for lenders to reprice their mortgages cheaper if they wanted to play for market share.
And happily for anyone needing a mortgage, they’ve done so.
Massive lender Nationwide is the latest to cut rates across the board and join the sub-4% five-year fix club. Recent Weekend Reading links have flagged previous entrants including Virgin Money, Natwest, HSBC, and the Yorkshire Building Society.
Hardly universal, but far better than average five-year rates above 6% following the Mini Budget.
Getting the best rates does typically require lower loan-to-value ratios of 60% or less. Across the spectrum, lenders seem to be being more judicious about who they lend their cheapest money to.
Whether you’re buying or remortgaging, putting in a little extra cash might save you a lot of money if it unlocks a cheaper rate band.
Resetting the game
For sure lenders aren’t chucking money around like its confetti again. The days of less-than 2% five-year fixes have gone, at least for the foreseeable. Hence the froth is coming off the pandemic-era price pop.
But while employment remains strong – and with many of those who are leaving the workforce apparently doing so because they can afford to, to the dismay of the chancellor – it’s hard to see rates at today’s more reasonable levels being a catalyst for a ginormous crash.
Maybe we’ll even stumble into what the UK economy both needs and fears – stagnant prices.
More young people would then get a chance to move out of the chillingly expensive rented sector sooner, and start building housing equity instead.
Inflation will have to abate though for the economics of stable prices to work for home builders, if we’re to avoid the knock-on of even fewer new homes being built. Workers are too scarce now for a big government house building program. We need to the commercial sector to keep at it.
And of course mortgage rates could start to rise again. The US stock market wobbled this week as various economic stats have suggested it will be longer before interest rates can be cut there.
Rates remains the greatest guessing game in town. Which is very unfortunate for anyone having to make long-term choices about paying for the roof over their heads.
