Why expats need money market funds
Are money market funds the best way to save for expats? Spoiler alert! They just might be.
This week we are going to take a deep dive into all things related to these alternative savings vehicles but here’s a quick summary:
They are about as low risk as anything out there and perhaps only more risky than cash.
And for that small risk you get a pretty compelling proposition.
- You can buy and sell them easily
- You don’t need to lock up your money
- You usually get higher interest rates than savings accounts
- They are low cost
- And tax efficient
Whilst they should be on everyone’s radar expats and non residents takes note:
Money market funds are made for UK non residents and expats with savings needs
Let’s get into it.
What is a money market fund?
Money market funds (MMFs) invest in high quality, low risk, short term debt securities which usually pay dividends in line with short term interest rates.
In other words, they invest in the safest stuff out there.
Typically, an MMF will hold some or all of the following:
- Commercial paper
- Corporate floating rate bonds
- Sovereign floating rate bonds
- Corporate fixed rate bonds
- Sovereign fixed rate bonds
- UK treasury bills
- Repurchase and reverse purchase agreements
- CDs (Bank certificates of deposits)
- Cash deposits
How do they compare to savings account?
Money market funds and savings accounts have a lot of similarities but they certainly aren’t the same.
Generally, money market funds come with higher interest rates, meaning you should end up with more money. Not only that, but you access your money any time (when the markets are open).
These are both big advantages of MMFs. It means you will have more money in the end and be able to access it more easily.
But there is one key advantage of a traditional savings account and that is that deposits in fund aren’t insured in the same way that cash in a UK bank account is.
As a result, there is a risk that you could loose money.
But just to be clear. The risk is small, and the expected amount of money you could loose should also be small but again its a risk you need to be aware of.
Why they are often perfect for expats and non residents
So whilst a money market fund is not a savings account, it does offer an extremely compelling alternative. And this is particularly true for expats and non residents.
In fact, I’m going to go out on a limb here and say it. I think they really are the best way for non residents and expats to save, period. (Full disclosure: I am heavily invested in MMFs).
And there are a few reasons for this.
As already touched on, they are very low risk and typically give equal or higher rates of interest than even the very best UK savings accounts.
But perhaps an even bigger sell for non residents and expats is the fact they are easy to access.
Anybody whose tried opening a bank account from abroad will know what I’m talking about.
UK high street banks don’t usually like to deal with non residents, and when they do, they don’t usually offer the same products and services that UK residents get.
Overseas alternatives either don’t offer savings or their interest rates are next to non existent.
The fact of the matter is, you usually pay a lot more in fees for inferior products and services. In fact, good luck trying to find a savings account that pays a decent rate of interest when you live overseas.
But all is not lost.
Money market ETFs
Anybody with an investment account can invest in a UK money market ETF in a couple of mouse clicks.
You can read more about ETFs here if you aren’t familiar with them.
Currently there are just three UK providers of Money Market ETFs. These are (in no particular order), Xtrackers, Lyxor and Pimco. And I think it’s pretty safe to say all three of these are large reputable companies.
Here’s a list of what is available at the moment.
I should just say the name of the fund is followed by the annual ongoing cost. And whilst all things being equal, lower is better in this regard, not one of them can really be considered expensive.
In addition, sterling based (or hedged) funds are underlined.
Xtrackers
- Xtrackers Fed Funds Effective Rate Swap UCITS ETF 1C / 0.15%
- Xtrackers Sterling Cash Swap UCITS ETF 1D / 0.15%
Lyxor
- Lyxor Smart Overnight Return UCITS ETF C-GBP / 0.07%
- Lyxor Smart Overnight Return UCITS ETF C-USD / 0.09%
- Lyxor Euro Overnight Return UCITS ETF Acc / 0.10%
- Lyxor Fed Funds US Dollar Cash UCITS ETF – ACC / 0.10%
PIMCO
- PIMCO Sterling Short Maturity UCITS ETF Dist / 0.35%
- PIMCO US Dollar Short Maturity UCITS ETF Dist / 0.35%
- PIMCO US Dollar Short Maturity UCITS ETF GBP Hedged / 0.40%
Why we like ETFs
There are a number of key advantages ETFs. Here’s a list of the main reasons for opting for one.
- You can sell/buy quickly and easily
- You don’t need to lock up your money
- Low risk (compared to just about everything except cash)
- MMF ETFs usually pay higher interest rates than savings accounts
- Low cost
- Tax efficient
What’s the catch?
So all good so far, but nothing in life comes for free so what is biggest disadvantage with this kind of product?
And the short answer… its not cash.
Cash comes with two key characteristics that differentiate it from just about everything else out there.
- It can’t go down in value (ignoring inflation and foreign currency comparisons)
- It is usually insured up to a certain amount in a savings account.
On the other hand, MMFs in theory could go down in value (a bit) and are unlikely to be insured in the same way.
But lets be clear, I doubt there’s anybody out there arguing that this level of risk is anything like what you take on when you invest in shares, bonds or BTL property to name but a few.
What riks do I need to be aware of?
Money market funds are subject to stringent regulations and invest in financial assets that are considered very low risk.
But……low risk doesn’t mean no risk.
Though very small, risk is risk is risk! And as with shares and bonds, a money market funds risk comes from the fact that you might not get all your money back when you want it.
Risk is a tricky subject to get your head around. It comes in more than one shade.
I think the simplest way to think about it is to compare one similar item with another. In this case, it’s probably useful to compare MMFs to some of the other more common investment assets.
And when you do that I think it’s safe to say – money market funds can be considered lower risk than shares, bonds and property but higher risk than cash.
Cash is as risk free as it gets because it can’t loose value (forgetting currency fluctuations & inflation) and it is usually insured (up to a certain amount) in a savings account.
If it ain’t cash there’s risk!
So quick recap: MMFs are pretty damn safe, but they ain’t cash! So there’s risk.
In the main, this risk comes from the fact that there is the possibility of a liquidity mismatch.
In other words, your fund can’t sell its holdings quick enough if too many investors want to get their cash back at once.
But in practice, this is only likely to become any kind of issue in times of severe market stress.
The biggest example of this occurred in in 2008 when some US investors were impacted as a large money market fund was forced to liquidate assets at a loss.
However, since that time there was widespread reform in both US and Europe (including the UK).
Now that said, even now, we can’t be one hundred percent sure that they are fully immune to any problems.
I say this because, during the Covid 19 Pandemic in 2020, a sniff of an issue arose because too many investors tried to move their money from an MMF into cash simultaneously.
The headline being: there weren’t enough buyers to meet sellers demands.
However, though this did temporarily strain the financial markets, it didn’t turn into any kind of real issue. No funds were suspended, and no disaster materialised.
So are they safe or not?
So are money markets sate or not?
I would say they are pretty much as safe as you can get for something that’s not actual cash. In fact I’d go so far as to say they are great choice and pretty much risk free for most people most of the time.
You just need to be aware that in times of severe stress you might not be able to get your money back immediately.
I think we are talking about it being held up for a while rather than it disappearing and if there is any loss incurred it really is more likely to be a percent or two, rather than the kind of double digit losses people experience with shares, property or even bonds for that matter.
That says to me, whilst not a place for emergency funds, MMFs can be a good enough place to park cash for more short to medium term savings. (Most people are going to be better with shares or property for anything longer term).
And this is particularly true for expats and non residents where choice is more limited.
What interest rate can I get with one of these things?
In the UK, a money market funds interest rate is usually based on the Sterling Overnight Index Average rate. This is commonly referred to as SONIA.
Here’s a few words from the Bank of England about SONIA:
We are the administrator for SONIA. That means we take responsibility for its governance and publication every London business day. SONIA is based on actual transactions and reflects the average of the interest rates that banks pay to borrow sterling overnight from other financial institutions and other institutional investors.
As I write this SONIA is just over 5%. You can view the current rate here.
There are a couple of elements that make accurately predicting your MMF returns with perfect accuracy difficult, though.
First up, SONIA fluctuates daily and second MMFs are actively managed.
That means you don’t really know what SONIA is going to be at any time in the future and it’s not beyond the realms of possibility for a fund to get better or worse returns than SONIA.
But here’s the thing. Due to the type of investment this is, any under or over performance is likely to be minimal.
So whist not set in stone, it is usually pretty reasonable to assume a similar return to SONIA for your MMF.
Of course, as with any funds, you need to account for any fees you pay, but the big one is nearly always going to be the ongoing charges figure (OCF) and this is usually pretty low with MMF ETFs.
What about tax?
In theory, money market funds are fully taxable.
The key being, this tax is applied to interest as per normal cash savings.
And this is true even if your particular money market fund talks about dividends in their literature. (For MMFs it’s just interest really).
But not everyone will pay tax on a MMF. In fact, lots of people won’t.
First up, non residents and expats aren’t usually liable to pay UK tax on savings interest anyway. Of course you may be liable in your country of residence. (But in many UK expat destinations you won’t be).
And along similar lines, if you are UK resident, you can avoid tax by sticking your MMFs in ISAs and Pensions.
UK residents holding them in a general investment account are the ones that usually end up paying. In that case they are taxed at your marginal rate of income tax.
But even then, you still might not end up paying tax because you can earn a certain amount of interest tax free from one or more of these UK government allowances:
The bottom line
Money market funds can be an excellent vehicle to grow your wealth.
Whilst they should be on everyone’s radar expats and non residents should pay special attention.
British Expat Money think they are the best way to save if you live abroad.
They are about as low risk as anything out there and perhaps only more risky than cash.
And for that small risk you get a pretty compelling proposition.
- You can sell/buy easily
- Don’t need to lock up your money
- Higher interest rates than savings accounts
- Low cost
- Tax efficient
