What should you do if you've decided that money market funds aren't for you? For the short term, bank deposits give you flexibility and the ability to move quickly, but their returns are low and currently do not keep up with inflation.
Whether the flexibility outweighs the value leakage is a personal decision. "The price you pay for having a reserve may be inflation erosion," says wealth planner Jonathan Fry. "It is better to get, say 3 per cent growth than the promise of 4 per cent or 5 per cent and then lose it."
But he adds that if you are prepared to take on a bit more risk and have more than a year or two to invest, rather than a money market fund, you should consider other assets.
■ Government bonds: Recent events in southern Europe mean that sovereign debt is no longer perceived as risk free. But shorter-dated UK government bonds are still an option. A tracker fund or an exchange-traded fund (ETF) can give you exposure at very low cost, which is a significant factor since the returns are likely to be quite low anyway. Vanguard UK Government Bond Index has a 0.15 per cent management fee and 10 per cent purchase fee, while the HSBC UK Gilt Index Fund charges 0.27 per cent.
■ Index-linked investments: If you want some inflation protection, you could opt for a fund investing in index-linked government bonds. The Vanguard UK Inflation-Linked Gilt Index has a 0.15 per cent management charge and 20 per cent purchase fee, while iShares does a Barclays Capital Sterling Index-linked Gilts ETF with a 0.25 per cent total expense ratio.
National Savings & Investments has recently issued a new tranche of its five-year Index-linked Savings Certificates, in which you can invest up to £15,000. Tax-free and guaranteed to beat Retail Priced Index (RPI) Inflation, these have proved popular and are likely to sell out soon.
Slightly further up the risk scale are Post Office inflation-linked bonds with the choice of a three- or five-year maturity. They offer a (taxable) return of retail-price inflation plus 1.5 per cent gross for the five-year term, and RPI plus 0.5 per cent gross for the three-year term. Read more on Post Office Inflation-Linked Bonds here.
iShares Barclays Capital Global Inflation-Linked Bond ETF offers exposure to inflation-linked bonds globally, though this could incur foreign exchange risk on top of government default risk. Its highest exposure is the US where there has also been some uncertainty, while Italy accounts for more than 8 per cent of assets.
■ Strategic bond funds: A strategic bond fund has more flexibility than a plain-vanilla corporate bond fund. But, while they may outpace inflation, their asset allocation and risk profiles change continually, so at times you could be in a fairly high-risk investment - and that will require a longer time horizon. More cautious funds with good returns include Fidelity Strategic Bond. Read more on Strategic Bond funds here.
■ Corporate bonds: Some corporate bond funds are fairly low risk, though at present the yields on some of these is below the inflation rate, especially if their allocation is more conservative. Options include M&G Corporate Bond and Henderson All Stocks Credit.
■ Absolute return: If you have a medium- to long-term horizon, some advisers such as Mr Fry say you could consider absolute return funds, which aim to make money in rising and falling markets. But it is difficult to compare these funds because the sector is very varied, and performance has been very mixed. For these reasons, Martin Bamford, managing director at Informed Choice, argues that absolute return funds are not a suitable low volatility option for low-risk investors. However, if you are tempted by absolute return strategies, funds with good performance records include Standard Life Global Absolute Return Strategies, although this only has a three-year track record and a complicated underlying strategy. See more fund suggestions here.
