How to earn a higher rate on your spare cash in ISAs and SIPPs

The interest rates that brokers pay on cash balances in investment accounts are slowly ticking up – but as usual, they remain well behind the Bank of England’s base rate.

Hargreaves Lansdown, the UK’s largest broker, pays 1% for balances under £10,000 (1.7% in a self-invested personal pension – Sipp), rising to a maximum of 2.3% on balances over £100,000 in a Sipp.

Most other brokers such as AJ Bell and interactive investors are similar. Some are noticeably less generous: Barclays Smart Investor pays no interest on an individual savings account (Isa) or Sipp. Vanguard quietly used to pay base rate minus a small deduction, which amounted to more than you could get in any cash Isa.

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However, after that got splashed all over various personal finance forums last month, the platform changed its terms and will now pay a fixed rate from later this month, initially set at 2.2%.

All of this is better than the zero that most brokers paid for the last few years (except for a few like Barclays, where clients might be well advised to grumble).

Still, many investors will wonder if there are ways to get a higher return if you’re holding a large amount of cash. And there is – but it is important to be aware that these funds are not the same as cash deposits.

Earn a better return on your ISA and SIPP cash

Cash makes a comeback In most brokerage accounts, you will be able to buy a range of funds with names such as “money market”, “liquidity” or simply “cash”.

These aim to deliver a return in line with a benchmark such as sterling overnight index average (Sonia), the rate at which UK banks and other institutions make overnight loans to each other. The funds do this by holding a variety of debt: bonds that are maturing soon, short-term loans to companies (known as commercial papers), deposits with banks and loans to financial institutions. Some of these debts may be repaid within days, others might have a maturity of a few months.

Details vary, but look at funds from big names – eg, BlackRock, Fidelity, JPMorgan, L&G and Royal London – and typically short-term loans to banks make up a large part of portfolios. That means that as interest rates rise, payouts should do so quickly as well.

For example, see the Vanguard Sterling Short-Term Money Market Fund (just because the website is clear and the 0.12% fee is low). It has 60% of its assets in bank deposits, with 40% having a maturity of less than one week. The weighted average maturity is just under 42 days. So while the fund has returned 1.75% over the past year (against 1.96% for the Sonia benchmark), averaging the last three payouts suggests a current yield of 3.2% and rising.

Short-term interest rates are now high enough that most money-market funds will pay out more than you can get in interest in any brokerage account.

Keep an eye on the costs of investing

However, you will generally pay some kind of dealing fee to your broker for buying and selling the fund. You’ll also typically pay a platform fee for holding it. These costs will vary between brokers, but you need to work out whether you’d make a meaningful gain compared to whatever interest rate your broker pays. The smaller the amount of cash you hold, the less likely you are to earn more.

Capital at risk

The big caveat is that money-market funds are not capital-protected, while cash deposits are almost completely secure (subject to the risks of the bank they are held in failing, and the limits of the Financial Services Compensation Scheme).

If the fund lends to borrowers who default, you could get back less than you invest. UK money-market funds are supposed to be conservative in terms of where they lend, and the risks are generally thought to be very low, but not zero. It is also possible that during times of market volatility, you might not be able to redeem your investment quickly. That said, all UK money-market funds made it through the severe test of March 2020 intact.

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