VAR Capital’s Guide to Cash, Fixed Deposits, and Money Markets: Pros, Cons, and Risks

This quick guide provides a comparative glance at the different vehicles available for managing cash holdings, each with its own set of features tailored to varying investor needs and market conditions.

Forms and Accessibility

1. Instant Access Accounts
   • Offer immediate cash access, provided by banks.
   • Interest accrues based on bank rates and market conditions.
2. Fixed Deposit Accounts
   • Feature a fixed term for cash deposits (e.g. 3 months, 1year, 2 years etc.), restricting access until maturity.
   • Again, interest accrues based on bank rates and market conditions.
3. Money Market Funds (MMFs)
   • Serve as an alternative to traditional bank accounts or deposits.
   • Managed by fund managers, investing in short-term debt securities to create diversified portfolios.
   • Investors buy shares in the fund, with returns typically from income, and occasionally, from income and capital gains.

Liquidity

1. Instant Access Accounts
   • Offer high liquidity, allowing on-demand cash access.
   • Rates typically lower given easy access.
2. Fixed Deposit Accounts
   • Provide limited liquidity; funds are typically inaccessible until maturity.
   • Early withdrawals may incur significant financial penalties.
   • Rates typically slightly higher than instant access accounts given the lock up period.
3. Money Market Funds (MMFs)
   • Feature same or next-day liquidity without withdrawal penalties.
   • Subject to transaction and management fees, which are often reflected in the fund’s yield.
   • Fees and returns vary by the fund manager administering the MMF.

Risks

1. Instant access and fixed deposit accounts
   • Counterparty Risk: There’s a risk of loss if the banking institution becomes insolvent.
   • Protection Measures: In the UK, the Financial Services Compensation Scheme (FSCS) offers compensation to account holders up to a certain limit if a bank fails.
2. Money Market Funds (MMFs)
   • Credit Risk: Generally low due to stringent regulatory guidelines and practices, ensuring investments in short-dated, high-quality securities.
   • Counterparty & Liquidity Risk: Reflects the fund’s ability to meet redemptions and is managed through strategies like maintaining high cash balances and diversification. Cash here is not protected by the FSCS.
   • Market Risk: As investment vehicles, MMFs are subject to market fluctuations. Medium-term MMFs may carry slightly higher duration and credit risks compared to their shorter-term counterparts.

Returns and Uses

1. Instant Access Accounts
   • Offer the lowest returns with variable rates, ideal for short-term liquidity needs.
   • Best suited for holding smaller cash amounts temporarily.
2. Fixed Deposit Accounts
   • Provide better returns with less access flexibility, as funds are locked during the term.
   • Rates are determined by the deposit term and bank agreement, making it a viable option for unused cash, balancing higher earnings with lower investment risks.
3. Money Market Funds (MMFs)
   • Yields can surpass both instant access and fixed deposit accounts but fluctuate continuously.
   • Managed actively to adapt to market shifts (however, returns then reduced by management fees)
   • Utilised for short- to medium-term financial goals, ensuring capital preservation and flexible liquidity.

Conclusion

This guide underscores that each cash management option caters to diverse investor preferences and market scenarios. Importantly, for those looking beyond the short term, a blend of fixed-income and equity investments may yield higher returns. As financial landscapes shift, grasping the intricacies of these instruments is key to enhancing cash management and investment strategies, ensuring a balanced approach to risk and reward in a changing economic environment.

VAR Capital is an independent financial services firm offering asset management, lending and family office services. It was founded by individuals with extensive experience from Banking, Asset Management and Family Offices. Based in Mayfair, London, VAR Capital Ltd is authorised and regulated by the Financial Conduct Authority (FCA).

Source: VAR Capital

Media Contact: Vikash Gupta, vikash@varcapital.com