Bond Funds vs 12-Month Fixed Deposits: A Practical Comparison
- Alpesh Patel
- 3 days ago
- 21 min read
Flagstone’s 12-Month Fixed Deposits – Yields and Key Features
Flagstone’s cash savings platform currently offers very attractive 12-month fixed-term deposits around 4.25%–4.4% AER (Annual Equivalent Rate) as of Dec 2025.
For example, new Flagstone customers can access rates like 4.42% AER for a 1-year fixed bond with National Bank of Egypt (min. £10k deposit) and 4.40% AER with Al Rayan Bank (min. £1k)[1][2].
Even standard offerings (for existing users) are in the mid-4% range (e.g. Chetwood Bank 12-month at 4.15% AER, £5k minimum)[3].
These rates already reflect Flagstone’s fee (they deduct up to ~0.25–0.30% of interest as their share[4]), so the net yield to the saver is as advertised.
Minimum Deposits: Minimum deposit requirements vary by bank, typically £1k–£10k for these top rates[1][5]. The highest 12-month rate (4.42%) requires £10,000, but others (like Al Rayan’s 4.40%) accept as little as £1,000[6].
Maximum deposit limits per account often range from ~£120k to £1 million[7][8], which matters for diversifying large sums across banks.
Early Access Conditions: Generally, funds are locked in for the full 12-month term – early withdrawals are not allowed or incur heavy penalties.
In most cases you cannot access your money until maturity, and breaking the term (if permitted at all) means losing some or all interest earned[9].
In practice, you should plan not to touch the money for the year. Flagstone even suggests “plan your withdrawals ahead of time” for when each fixed term matures[10].
Interest Payment and Reinvestment: Fixed deposits pay interest either at maturity or periodically (e.g. monthly or annually), depending on the account[11]. Many 12-month bonds pay interest at the end of term, so you only realise and reinvest interest once the year is over (no compounding during the term, although the advertised AER accounts for it if paid periodically).
This means your interest can’t be reinvested into the same account before maturity. By contrast, some accounts offer monthly interest payouts (which Flagstone would typically credit to your cash hub, where it unfortunately earns no interest until redeployed[12]). Thus, there’s a slight efficiency loss unless you immediately move those interest payments into a new savings account.
FSCS Protection: A major advantage of bank deposits is capital security. All these Flagstone offerings are with UK-regulated banks or branches, so deposits are covered by the Financial Services Compensation Scheme for up to £120,000 per person, per bank[13] (the FSCS limit was raised from £85k to £120k in Dec 2025).
This means your principal (and accrued interest) is guaranteed by the government-backed scheme up to that limit in the event the bank fails.
Flagstone’s platform makes it easy to spread large cash balances across multiple banks to stay within FSCS limits for each bank, providing full protection on very large sums (each account up to £120k) while still getting top rates.
In short, a 12-month fixed deposit on Flagstone offers virtually risk-free return (assuming you stay within FSCS limits) – you’ll get your deposit + 4+% interest back with certainty, barring bank default beyond coverage.
Tax Treatment: Interest from these deposits is classified as savings income. It is paid gross (without tax withheld), and if held outside a tax shelter, it’s taxable at your marginal rate after applying any Personal Savings Allowance (PSA).
Basic-rate taxpayers have a £1,000 PSA, higher-rate £500, and additional-rate £0[14][15]. At ~4.25% interest, a basic-rate taxpayer hits the £1,000 interest allowance with about £25k saved (since 4% of £25k is £1k)[16].
Any interest above that is taxed at 20% (or 40%/45% for higher earners), which reduces the net yield. For example, an additional-rate taxpayer would net only ~2.34% from a 4.25% account (since they pay 45% tax on all interest and have no PSA).
There is no special tax advantage to fixed-term deposits – unless you use a cash ISA product. (Flagstone is in the process of launching Cash ISA offerings by 2026, but currently their platform deals are mostly taxable accounts.)
In summary, inside an ISA the 4.25% would be tax-free, but outside an ISA the net yield could be significantly lower for large deposits or higher tax bands. (By comparison, bond fund income is treated similarly – discussed below – so the playing field is level on tax if both are unwrapped or both in an ISA.)
Yields and Risk Profiles of UK Bond Funds
If 4.25% guaranteed for 1 year is the benchmark, how do UK bond funds stack up in yield and what risks do they carry?
We’ll consider three categories of low-risk bond investments in the UK: money market funds, short-duration investment-grade bond funds, and gilt funds.
These instruments have different yield levels and risk profiles, which we compare to the fixed deposit:
Money Market Funds (Ultra-Short-Term Cash Funds): These funds invest in very short-term, high-quality instruments (like Treasury bills, bank deposits, commercial paper) and aim to preserve capital and provide liquidity.
Right now they yield roughly 4.5%–5.1%. For example, a sterling money market fund like Royal London Short Term Money Market Fund has a distribution yield around 5.1%[17].
Yields closely track the Bank of England base rate, so with base rates around 5%, many money market funds are paying just under that (after fund fees).
Risk: Money market funds are considered very low-risk: they maintain extremely short duration (often <60 days) so interest rate volatility is minimal, and they hold a diversified pool of highly rated, short-term debt.
While not FSCS-guaranteed, losses are rare – the fund’s NAV is meant to be very stable (some are structured to target a constant £1 unit value). The main risk is that yields will float – if interest rates drop, the payout of a money market fund will decline (unlike a fixed 12-month deposit which locks the rate).
But in terms of capital, one typically won’t see meaningful losses in a standard money market fund.
Short-Duration Investment-Grade Bond Funds: These funds invest in high-quality corporate bonds (and sometimes government bonds) but keep duration short (e.g. average maturity ~1–3 years) to limit interest rate risk. They currently offer yields in the mid-4% range. For instance, Royal London’s Short-Term Fixed Income Fund yields about 4.4% (distribution yield) with a yield-to-maturity around 4.23%[18]. Yields here are a bit higher than cash deposit rates because you’re taking some credit risk and a bit of interest rate risk. Many UK corporate bond index funds yield around 4–5% depending on duration. (Vanguard’s broader UK investment-grade bond index fund – with ~5-year duration – yields >5% YTM currently[19], so a shorter 1-3 year version will be slightly lower, mid-4s.) Risk: Short IG bond funds carry moderate interest rate risk – their prices can fluctuate with bond market moves, though with a short duration the volatility is limited. They also have credit risk: they hold corporate bonds (rated investment-grade), so there’s a very low but non-zero chance of default or credit downgrades affecting value. The diversification across many issuers mitigates idiosyncratic default risk, and IG defaults are rare. Overall, a short-term corporate bond fund might experience small price drawdowns if interest rates rise or credit spreads widen. But notably, if rates fall, these funds can gain value as their bond prices rise. Yields ~4.3–4.5% are similar to the deposit’s 4.25%, but here the 4+% is not “guaranteed” – it’s an expected yield that could be offset by price changes. Total return could end up higher or lower than 4.25% depending on rate movements over the year.
Gilt Funds (UK Government Bond Funds): UK gilts (government bonds) are essentially free of credit default risk (backed by HM Treasury), but their yields and risk depend on maturity. Short-term gilt funds (focused on maturities under ~5 years) yield on the order of 4.0% currently. For example, an index fund of 0–5 year UK gilts has a current yield ~4.0%[20]. All-maturities gilt funds (which include long bonds) yield slightly more (~4.2–4.3% at present)[21], but only because they hold longer-duration bonds which are much more volatile. Risk: Short-duration gilt funds have low volatility (though a bit more than cash) – their prices will dip if Bank of England rate expectations rise, but with duration only a couple years, a 1% rate move might move the NAV by ~2% or so. Longer-term gilt funds, however, are quite volatile: even though the yield (~4.2%) is on par with a 4.25% deposit, a broad gilt fund might have a duration near 10–12 years, meaning a 1% interest rate shift can move price ~10% – so one could easily see capital losses or gains of 5–10% in a year. Indeed, 2022 was a stark reminder that bond funds can lose significant value when yields spike (UK gilt funds fell sharply when inflation and fiscal worries drove yields up). On the flip side, government bonds have high liquidity and, if held to maturity, would pay out exactly their face value – but in an open-ended fund you don’t have a single maturity date. In summary, gilt funds offer a “safe” income in credit terms but come with interest rate risk. A short-term gilt fund is a fairly low-risk, low-volatility investment (yield ~4%), whereas a long gilt fund is riskier than even many stock funds in the short run.
For context, current yields on short-term bonds are historically high due to the elevated interest rates in 2025. The yield curve in the UK is somewhat inverted, meaning short-term rates are as high as or higher than long-term rates. For example, the UK 2-year gilt yield was ~4.2% as of early 2025[22], not far below the 10-year yield ~4.5%. This implies you don’t get paid much extra yield to take more duration risk – one reason many investors are favouring short-duration bonds.
In fact, the average 1-year fixed savings bond (4.01% in Aug 2025) was yielding more than the average 5-year fixed savings bond (3.91%)[23], reflecting expectations that rates will eventually fall. Short-term bond funds let investors capture those relatively high short yields without committing to low long-term yields.
Key Decision Factors in Choosing Deposit vs Bond Fund
When deciding between a 12-month fixed deposit and a bond fund, a UK investor should weigh several key factors:
Net Yield (After Fees & Tax): On a pure yield basis, the fixed deposit’s 4.25% is a guaranteed gross rate. Flagstone’s platform fee is built-in (the rates shown are net to you[24]), so you actually get the full 4.25% AER. Bond funds, by contrast, have fund management fees (often ~0.1–0.3% annually for index funds) and possibly platform fees if held through an investment platform. That might modestly reduce the effective yield (e.g. a fund yielding 4.5% gross with a 0.2% fee nets ~4.3%). On an after-tax basis, both deposit interest and bond fund interest distributions are taxed as income (unless in an ISA/SIPP). This means if your interest exceeds the PSA, a chunk of that 4.25% or the bond fund’s yield will be lost to tax. In other words, neither option has a tax advantage outside of wrappers. However, a difference arises if you can use a tax shelter: you can hold bond funds in a Stocks & Shares ISA or pension and thereby get the yield tax-free.
Whereas Flagstone’s 12-month deposits are not in an ISA (Flagstone is launching cash ISAs later, but typical fixed-term accounts on the platform now are taxable). While you could use a Cash ISA at a bank to get tax-free interest, the available ISA fixed rates might be a bit lower than 4.25% (often cash ISAs pay slightly less for the tax benefit). Thus, for higher-rate taxpayers especially, a bond fund in an ISA could deliver a better net return than a 4.25% taxable deposit. Always consider your personal tax situation: for example, a basic-rate saver earning 4% can shelter about £25k before tax kicks in[16], but a higher-rate saver earning 4% on a large sum will see their net yield drop substantially (e.g. to ~2.55% after 40% tax). In summary, if using tax shelters, both can be made tax-free; if not, expect to lose similar amounts of interest to tax above the allowance.
Capital Security: The 12-month fixed deposit offers rock-solid capital security (up to FSCS limits). If you stay within £120k per bank, your principal will not be lost, regardless of economic conditions[13]. You also know exactly what return you’ll get (interest rate fixed) barring bank failure (which is covered anyway). This certainty is ideal for the risk-averse saver who “wants to guarantee returns, rather than being at the sharp end of rapidly changing markets”[25]. Bond funds, on the other hand, do not guarantee your capital – the value of your investment will fluctuate day to day. Even though high-quality bond funds are relatively safe, the NAV can drop if interest rates rise or if credit fears increase. There’s no FSCS guarantee on market value (funds are not deposits), though note that the fund’s assets are segregated – you won’t lose money due to the fund manager’s insolvency, only due to market movements. Government bonds are backed by the government, so default risk is negligible, but you could still face mark-to-market losses if you sell after yields have risen.
Corporate bond funds add a slight default risk (mitigated by diversification). In short, with a bond fund your capital is not 100% secure – there’s a risk of loss, especially in the short term. With a fixed deposit held to maturity, your capital + interest outcome is predetermined and protected. This is arguably the biggest difference between the two: one is principal-guaranteed (with FSCS), the other is principal at risk (market risk).
Potential for Capital Gains or Losses: Because a fixed deposit pays back a fixed sum, you have no chance of getting more than the agreed interest. There is zero upside beyond the 4.25% interest – but also zero downside (assuming no default). In contrast, bond funds’ total returns can exceed the yield or drop below it, because bond prices move inversely to interest rates. If market yields fall during your holding period, a bond fund will see its asset prices rise, giving you a capital gain on top of the interest coupons. For example, if the BoE cuts rates and 1–3 year bond yields drop, a short-duration bond fund could easily return, say, 6–7% in a year (perhaps ~4% yield + a few percent of price uplift). This is a key advantage of bond funds: in a declining rate environment, they can outperform a fixed-rate deposit[26]. Conversely, if yields rise further or credit spreads widen, a bond fund can lose value (the price drop could offset interest income, yielding a lower or even negative total return). A deposit in that scenario is better because you don’t suffer from rising rates (you’re locked at 4.25%, and you’ll still get your full interest). Essentially, with a bond fund you are making a bet (or hedge) on interest rate movements: you have upside if rates fall, and downside if rates rise, whereas the deposit isolates you completely from that market risk. Importantly, for longer-term investors, bond funds also can generate capital gains simply by holding bonds to maturity – but since funds continually roll their portfolios, the gains/losses manifest via NAV changes. Any realised capital gains when you sell fund shares could be subject to Capital Gains Tax (though gilts and qualifying corporate bonds held directly are CGT-free, that exemption doesn’t apply to bond funds)[27][28]. The CGT rate (10–20% typically) might be lower than income tax, which is a subtle benefit if you make a sizable capital gain on a bond fund (and have not sheltered it). However, predicting and timing interest rate moves is not easy, so this factor mainly boils down to your view on interest rates and comfort with volatility. If you believe rates will drop (or even could drop) in the next year, a bond fund offers an opportunity for extra return that a fixed deposit cannot give. On the other hand, if you think rates will stay high or rise, the bond fund could disappoint while the deposit delivers reliably.
Interest Reinvestment & Income Flexibility: A bond fund typically pays out interest (distributions) regularly (monthly or quarterly), or you can choose accumulation units that reinvest interest automatically. This means your interest can compound continuously as the fund reinvests coupons into buying more bonds. With an accumulation share class, you effectively earn interest on interest without manual intervention. With a fixed-term deposit, interest is often locked until maturity. If the account pays only annually or at maturity, you cannot deploy that interest until the term ends (it’s effectively compounding at the same fixed rate, which is fine for one year). Some fixed bonds offer monthly interest payout, which could be helpful if you want income, but if you want to reinvest those monthly payments you’d have to move them to a new account yourself. Moreover, if that interest sits in your bank or Flagstone hub uninvested, it earns nothing until reinvested[12]. Bond funds therefore provide automatic reinvestment (in accumulators) and greater ease of compounding. They are also more flexible for taking income: you could opt for an income share class and have monthly interest paid out to you as cash (useful if you want a regular income stream). A fixed deposit, in contrast, typically doesn’t provide monthly cash flow (unless explicitly a monthly interest product), and even then you wouldn’t withdraw principal. So in terms of interest management, bond funds are more flexible – you can choose to compound or draw an income, and adjust that anytime by switching share class or selling some units.
Fees and Platform Costs: As noted, Flagstone’s platform does not charge an explicit fee to consumers; instead it takes a cut of the interest (up to ~0.30%) such that the rate you see is net[24][4]. If Flagstone advertises 4.25%, you’ll get 4.25%. There are no additional admin or account fees on Flagstone[29]. By contrast, investing in bond funds may incur fund management fees (the fund’s OCF, which is typically directly taken out of the fund’s returns) and possibly a platform fee depending on where you hold it. For example, many UK brokers charge ~0.2–0.4% annually on funds held in an ISA/GIA, and the bond index fund itself might have a fee around 0.1%. There are low-cost platforms (even free ones for ETFs) that can minimise this, but one should consider that part of the bond fund yield will go towards fees. In pure numbers, the “fee drag” is of similar order for both options: Flagstone skims perhaps 0.1–0.2% on many accounts (already reflected in that 4.25% rate), while a bond ETF plus platform might cost 0.2–0.3% combined. If you use a commission-free broker and a low-cost ETF, the cost could be under 0.1%. In any case, be aware that a bond fund’s headline yield is gross of its internal fees – e.g. a fund yielding 5.0% with a 0.2% OCF is effectively 4.8% to investors. With the deposit, the 4.25% is net to you, but you had no say in the 0.25% that Flagstone took behind the scenes. Also note that Flagstone has minimum balance requirements for personal accounts (often a £50k minimum initial deposit to use the platform, unless coming via certain routes), whereas one can invest in bond funds with much smaller sums. This could be a factor for investors with more modest amounts.
Liquidity and Access to Funds: A major difference is liquidity. Fixed-term deposits are illiquid – you cannot ordinarily withdraw your money until the 12-month term ends (aside from extreme hardship cases or by forfeiting interest, and even those options may not be available per the terms)[9]. You have committed to lock that cash up. Bond funds, in contrast, offer easy access and daily liquidity. You can sell your fund holdings on any trading day and typically get the cash from your broker in 2–3 days. There are no penalties for selling (other than any market loss that may have occurred). This flexibility can be very valuable if you think you might need the money on short notice. Essentially, bond funds act like liquid investments – you can rebalance or liquidate anytime – whereas a 12-month deposit ties your hands. Even “notice” savings accounts (which Flagstone also offers) require say 90 or 120 days notice; by comparison, selling a short-term bond fund will get you cash much faster. The flip side: if you do withdraw from a bond fund, you might get slightly less (or more) than you put in, depending on market conditions – whereas a withdrawn deposit just gives your principal (minus interest penalty, if early withdrawal were allowed). In summary: Liquidity needs are a crucial consideration. If there’s any chance you require funds within the year, a bond fund or money market fund (with same-day access) would be preferable. The fixed deposit is for money you are confident you won’t need until next Christmas, as getting it out early is essentially off the table.
When Would a Bond Fund Be Preferred Over a 4.25% Fixed Deposit?
Given that a 4.25% 1-year fixed deposit is risk-free and fairly high-yielding, in what scenarios might a UK retail investor rationally choose a bond fund instead? There are several situations where a bond fund could be the better (or more suitable) choice:
Expectation of Falling Interest Rates (Capital Gain Potential): If an investor strongly expects rates to fall in the near future, a bond fund becomes attractive because it can deliver capital gains that a fixed deposit cannot. For example, suppose the Bank of England starts cutting rates in 2026 – short-term yields might drop from ~4-5% down to, say, 3%. In that scenario, bond prices will rise (especially for bonds with a few years to maturity). A gilt or corporate bond fund could easily return more than its starting yield. Analysts at AXA IM noted that they anticipate 75 bps of rate cuts in 2025, leading to falling front-end yields[30]. In such a case, a short-duration bond fund could not only pay ~4–5% income but also perhaps a few percent in NAV appreciation. The total return might beat the fixed 4.25% by a good margin. Essentially, a bond fund lets you lock in today’s higher yields for longer than 12 months – or sell at a profit if yields drop sooner. In contrast, a 1-year deposit gives you 4.25% and then you’ll have to reinvest at the new lower rates (with no price upside). Thus, if you foresee a downward rate cycle or even a sharp one-off drop (e.g. an economic downturn prompting BoE cuts), a bond fund is a rational pick to capitalise on that interest rate movement. (It’s worth noting the inverse: if you fear rates might rise further, you’d prefer the deposit – and indeed many chose cash over bonds in 2022 when rates were rising. But as of late 2025, the bias in market expectations is toward rate cuts, not hikes, which tilts the balance more in favor of bonds’ upside.)
Need for Liquidity or Flexibility: An investor who might need access to the funds on short notice (or simply wants the option to reposition assets dynamically) would lean toward a bond fund. The liquidity of bond funds (daily tradability) means you can always change your mind, whereas the fixed term deposit is inflexible. For example, suppose halfway through 2026 you find a better investment opportunity or have an emergency expense – if your money is in a bond fund, you can sell and redeploy it; if it’s in a locked deposit, you’re stuck or face losing the interest. Also, if market conditions change, you can actively manage a bond fund (e.g. switch to a longer-duration fund if you think rates will fall more, or move to cash if you’re worried), whereas a deposit is on autopilot. In summary, if you value liquidity or may need the cash before 12 months, a bond or money market fund is the safer choice. Even for slightly longer horizons, bond funds avoid the “lumpiness” of fixed terms maturing on a set date – you can withdraw or add incrementally at any time.
Tax and ISA Considerations: For some investors, the choice might hinge on tax wrappers. If you have room in a Stocks & Shares ISA, you might prefer to hold a bond fund there to get ~4–5% tax-free, especially if you’ve already maxed your Cash ISA or if cash ISA rates are lower. A cash ISA equivalent of that 4.25% deposit might be hard to find or slightly lower in rate (often fixed cash ISAs pay a bit less interest). Meanwhile, you could buy a short-term government or corporate bond ETF in your S&S ISA and net perhaps 4–5% tax-free with no FSCS limit concerns. This is rational especially for higher-rate taxpayers: outside an ISA, the 4.25% deposit interest would be heavily taxed (reducing effective yield to ~2.5% or less for 40%+ taxpayers), whereas inside an ISA a bond fund yielding 4.5% keeps you the full amount. So the after-tax return could favor bond funds when using an ISA/SIPP. Additionally, as noted earlier, bond funds can deliver part of their return as capital growth. If held outside an ISA, that growth would fall under CGT (which might be advantageous if you haven’t used your CGT allowance and are in a high income-tax bracket, since CGT rates (18–20% for most) are lower than income-tax on interest)[31]. That said, this is a secondary scenario – most retail savers would simply use an ISA to equalize the tax situation. But it’s worth noting: if you cannot shelter the interest on the deposit and it will be taxed, while you can shelter or more favorably tax the bond fund returns, the bond fund can come out ahead net of tax.
Large Balances and Diversification Beyond FSCS Limits: If an investor has a very large sum to invest, going above FSCS limits, diversification of risk becomes important. Flagstone does allow splitting among many banks to stay within £120k per bank, but you might eventually run out of convenient banks or find it cumbersome to manage dozens of accounts. Bond funds provide a form of diversification of issuers without worrying about specific bank default risk. For example, a gilt fund is essentially backed by HM Government (effectively no default risk up to sovereign level), and a corporate bond fund spreads risk across perhaps hundreds of companies. While this doesn’t give the absolute guarantee FSCS does, it avoids concentration in any one bank. Additionally, for amounts far above FSCS limits, even a slight concern about banking system risk might make an investor uncomfortable keeping all money in bank deposits (even if split). In such a case, spreading some into government bonds or a high-quality bond fund could be seen as rational. It’s not that the bond fund is safer (it’s not, in pure terms of guarantee), but it avoids the scenario of a single point of failure.
That said, in the UK context, using multiple banks via Flagstone largely mitigates this. Still, one could argue that gilts have the backing of the UK Treasury for the full amount (no £120k cap), so holding gilts directly or via a fund means no cap on protection (apart from market fluctuations). Some extremely cautious investors with >£1m might trust gilts over deposits for this reason. In summary, if you have so much cash that FSCS limits are a constraint, you might allocate some to gilt/bond funds as an alternative safety strategy – accepting price volatility in exchange for sovereign backing on the bonds.
Investment Horizon and Reinvestment Risk: Consider an investor with a medium-term horizon (say 2–5 years) who is simply evaluating the next 12 months for placement. A 1-year deposit gives a known return now, but then you face reinvestment risk in a year – if rates fall, your next deposit might be at much lower interest. By contrast, if you invest in a short-to-intermediate bond fund now, you lock in the bond yields which often extend beyond one year. For instance, a bond fund with average 3-year maturity is effectively locking in yields for 3 years on its holdings (absent defaults). If rates fall, the bonds in the fund will continue paying the higher coupons and also become more valuable. This can provide a rolling advantage over just doing a 1-year deposit then rolling into presumably lower rates. In other words, for a longer horizon, bond funds can smooth or reduce reinvestment risk. You could also directly buy a 3 or 5-year government or corporate bond to maturity – but a fund gives you diversification and flexibility to sell if needed. Additionally, if one’s goal is to invest rather than just save, bond funds integrate better into a portfolio. They can be mixed with equities and rebalanced, and they provide the potential for capital appreciation that can contribute to total return over multiple years. An investor seeking to hedge against equity risk or gain from a potential economic downturn might prefer holding some gilts (which typically rise in value if recession hits and yields tumble). A fixed deposit won’t rise in value in a market shock – it just sits isolated. Thus, in a portfolio context, bond funds serve as a more dynamic tool for asset allocation. If you’re constructing a balanced portfolio, you might rationally include short-term bond funds for the fixed income portion rather than cash deposits, despite the similar yield, because the bonds can provide a buffering effect (e.g. if stocks crash and central bank cuts rates, bonds rally, helping offset equity losses – whereas cash just stays flat at best).
Interest Income Needs: If an investor requires regular income (say monthly interest to cover expenses), a bond fund (or a ladder of bonds) might be preferable. Many bond funds pay out monthly or quarterly distributions, which can be ideal for income planning. A 12-month fixed deposit typically pays interest only annually or on maturity, so it’s not helpful for month-to-month cash flow. While you could ladder multiple deposits with staggered maturities to simulate income, it’s more work. A bond fund offering ~4-5% yield paid monthly provides a smoother income stream. So for someone in drawdown or needing interest as income, bond funds offer convenience. (However, note that some banks do have monthly interest fixed accounts – though not all, and you’d still have the issue of principal lock-up.)
In conclusion, a UK retail investor would typically choose a bond fund over a 4.25% fixed deposit in scenarios where flexibility, market outlook, or tax efficiency make the risk-return trade-off favourable. If you believe interest rates will decline or you need liquidity, or you can leverage tax shelters to get more net yield, a high-quality bond fund can be worth it – despite the absence of an FSCS guarantee. Essentially, the bond fund is worth using when you expect its effective return (considering potential price changes and your personal circumstances) to beat the deposit’s assured return, or when you require features the deposit lacks (accessibility, ongoing compounding, integration in an investment portfolio).
However, if none of those scenarios apply – e.g. you just want a safe place for cash for 12 months and expect rates to stay flat – then the 4.25% fixed deposit (FSCS-backed) is hard to beat for a no-risk, hassle-free return. The hurdle for the bond fund to clear is fairly high in that case, since taking risk would not be compensated by a higher yield. Thus, many rational investors are currently parking cash in such deposits. The bond fund only becomes compelling if you have a specific reason to take on risk or need the flexibility. As one Flagstone commentary put it, “while inflation remains sticky, investors may not see real returns immediately, so choosing from the 600+ fixed bonds that outpace inflation could be sensible”[32] – in other words, with cash yielding 4-5% and inflation around that level, the case for bonds comes down not to yield superiority but to strategic factors like those above. Each investor should weigh these pros and cons against their own goals and market view to decide the optimal approach.
Sources:
[16] DIY Investor - The Do-It-Yourself Investing Blog
[17] Royal London Short Term Money Market Fund Y Inc Dividends
[18] Royal London Short Term Fixed Income Fund
[19] New short-term gilts fund completes our UK bond line-up | Vanguard UK Professional
[20] iShares UK Gilts 0-5yr UCITS ETF GBP (Dist) | A0RL84 - justETF
[21] iShares Core UK Gilts UCITS ETF - DivvyDiary
Disclaimer: This article is for educational purposes only and does not constitute financial advice or a recommendation. Rates, yields, and tax treatment may change, and capital values can go down as well as up. Savings products are subject to provider terms and FSCS limits. Bond funds are market-linked and not FSCS-protected. Always consider your personal circumstances and, where appropriate, seek advice from a regulated financial adviser.
Alpesh Patel OBE