Alternatives to savings accounts as interest rates fall

With the Bank of England having cut interest rates to 4.25%, the amount you can earn on your money in a Cash ISA might fall if you’re on a variable rate. It’s therefore an appropriate time to consider alternative ways to generate an income from your hard-earned money using a Stocks and shares ISA.

Here are some of the lower-risk investments that could generate an income, and which shelter your income and capital growth from the taxman just like a Cash ISA.

Money market funds

Money market funds have seen growing demand from Stocks and shares ISA investors in recent years. They predominantly invest in short-term deposits with banks, and short-term loans to governments, banks and large companies. Some of these loans take place for as short a period as overnight.

The return from the average money market fund in 2024 was 5.25%. It’s important to remember that past performance isn’t a guarantee of future returns. The yields offered by these funds are variable and they are impacted by short-term interest rates.

Money market funds typically have low levels of volatility, which might interest more cautious investors.

There are two sectors containing money market funds – called the Standard Money Market sector and the Short-Term Money Market sector. Funds in the latter are required to hold more of their portfolio in short-term assets, in theory making them more liquid and secure.

Over the last 10 years, the average money market fund racked up a maximum loss of just 0.1% over its worst period. That was when interest rates were close to zero, so not a great period for money market funds. And because yields were so low, overall returns were heavily influenced by annual fund management charges.

The situation is different today. Although interest rates have decreased from levels seen in 2024, they remain at much higher levels than a decade ago.

Fund management charges are generally low, on average just 0.15%. Just be aware these funds don’t guarantee positive returns, and you should consider platform fees for holding the funds, too.

Bond funds

Bonds are essentially an IOU. Investors lend money to governments and companies in exchange for a set rate of interest, with the original face value of the bond repaid at a set date in the future.

Clearly, fluctuations in valuation mean there is some risk, but bonds can lower the volatility of a portfolio that also contains shares. That’s because bond prices, especially those of developed market government bonds, often to move in the opposite direction to share prices, so if you hold both in your portfolio, you should get a smoother ride.

Some bond funds invest predominantly in government bonds, while others invest almost exclusively in corporate bonds. Strategic bond funds can invest in both areas.

You may also come across high yield bond funds, which invest in the debt of companies that have a low credit rating. That makes these bonds riskier, but they usually carry higher yields as a result, which might interest more adventurous income-seekers.

Read more about the bond market

Individual gilts and corporate bonds

If you prefer, you can buy individual UK government bonds (also called gilts) and corporate bonds instead of a bond fund.

Last year saw an uptick in the number of investors using individual gilts to park large sums of money and lock in higher interest rates, with the asset type acting as an alternative to cash.

Certain investors bought gilts to benefit from their capital gains tax-free status. Individuals who had maxed out their ISA allowance might have bought gilts with the goal of making a capital gain. When they come to sell those gilts, they would pay no capital gains tax on any profits.

Corporate bonds are loans to companies and there is often a higher risk of default compared to bonds issued by developed market governments such as the UK or US.

The price of bonds fluctuates on the market, but there will be a maturity date for each bond, at which point you’ll get the face value of the bond back, unless there’s a default. The price you receive may be more or less than you paid for it, unless you bought when the bond was originally issued.

Individual bonds can be a bit tricky to get your head around, so this approach is probably best left to more experienced investors or those who are willing to roll up their sleeves and delve into the nitty gritty.

Multi-asset funds

Multi-asset funds are another way to earn as you save. As the name suggests, these funds invest across a range of assets, including shares, property, commodities, bonds and cash. Most should pay dividends that create an income stream for the investor.

Multi-asset funds come in a range of risk profiles to suit investors with different appetites for volatility, so the amount of exposure you can get to bonds and cash ranges from very low to very high.

These funds might interest investors who want a mix of assets in their portfolio, but also want a professional fund manager to pick and choose what to invest in.

Data for fund charges and performance comes from Morningstar

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