There are quite literally hundreds, if not thousands, of financial products available throughout the market, but fortunately, you don’t need to concern yourself with most of them. They can be left to the pinstriped suits in the City of London.
That said, in order to develop your financial literacy, you do need to understand the basic financial products available from banks and building societies, and how they work.
Financial products - Bank accounts
These financial products are used for day to day banking, and you will certainly need one when you enter the working world. Most employers will insist on paying your wages into a bank account and also using them as a form of identification.
Current accounts will pay very little interest if anything at all, but they should not be used for savings, more of a transactional account that receives income such as your wages, and pays for things via direct debit, standing order, cheque book, debit card payments, or by cash withdrawal at a cash machine.
You should aim to keep your current account in credit, but not by a large amount. Any excess cash you have over and above your planned monthly spending budget should be moved to a savings account or other investment.
Savings financial products or accounts are used in a different way to a current account. They are not designed for high volumes of transactions, or day to day banking, but less frequent saving activity.
There are many different types of savings financial products available, but they all have the same overall purpose, of increasing your money by the payment of interest, in a safe and secure financial product. Safe and secure in this context means you are guaranteed to get your money back, which isn’t always the case, as we shall find out later.
The payment of interest is a savers “reward” for allowing the bank to look after and use your money. Interest rates are advertised as a % or percentage, showing the saver how much they can expect to earn in interest if they put their savings in a particular type of account or a particular bank.
For example, if the headline rate said 5% interest, you would know that for every £100 you saved, you would earn £5 of interest, over the course of a year.
The most common types of financial products savings accounts are:
Easy access – These financial products provide the most flexibility, as you can put in and take out your money without any notice, and without any penalties. The downside is, that they usually pay a lower rate of interest for this flexibility.
Notice account – These accounts should provide a higher rate of interest because you must give the bank “notice”, that you wish to have your money back. This notice period can be anything from 30 days, 90 days, or even 180 days, so it’s important to understand exactly which product you are considering, as you will be charged a penalty if you don’t give enough notice.
Regular saver – These are designed to encourage the savings habit of little and often. Interest rates are usually much higher than the other types of account, but you must commit to saving something, each and every month for at least a year, even if it is just £25. These types of account also have a maximum upper limit, which is usually in the region of £250 - £500 per month.
Long term bond – These financial products are designed for longer-term savings with fixed lump sums. If you had £1,000 and knew you wouldn’t need it for a long time, then this type of account may be an option. You could choose to have a one year, three year, or five year bond that should pay a higher interest rate, the longer you commit your money for. You would need to understand the terms, and any penalties of these products before you used them, as five years is a very long time to tie your money up if you cannot gain access to it.
Tax-free – There are other financial products that pay interest tax-free called ISA’s, but the benefit of these have been reduced in recent years, by a combination of low-interest rates, and increased tax-free savings allowances. Unless you have a significant lump sum to invest in a savings account, it is unlikely you will exceed your savings interest allowance.
Debit cards are the plastic cards which are issued with current accounts and some other accounts, which allow you to take money out of a cash machine. They also enable you to pay for goods at the counter, using chip and pin, or contactless payment. With a debit card, you are spending your own money. If you have no money in your account, then they shouldn’t work, although it is recognised that some banks do let you go slightly overdrawn, in case of emergencies by £50 or £100.
Credit card financial products work in a similar way to debit cards as far as usage goes, but the very important point to remember about credit cards is that you are spending the bank's money and not your own. See the dangers of credit.
Financial products - Investments
We will cover investments in more depth here, but for now, a brief overview of some of the main types of investment financial products sold by banks, building societies, stockbrokers and other financial institutions will suffice.
Stocks & shares
Also known as equities, are investments in companies and businesses, listed on the various stock exchanges around the world. When you buy and own stock, you own a small part of that business, which entitles you to a share of any profits made, and any increase in the value of your shares.
An ISA, or Individual Savings Account, is a tax-free saving or investment vehicle, which protects your money from the taxman. Think of it more as a protective box, or wrapper, that you can save or buy investments through, completely free of tax.
Is the junior version of the ISA, for those under 18 years old.
Not to be confused with the savings bonds discussed earlier. These types of financial products, are IOU’s or loans to businesses or Governments. Buying these bonds provides money to third parties, which in turn, entitles you to earn interest on them, also known as the coupon. Any interest is usually paid quarterly, semi-annually or annually depending on the bond.
Property investments can involve either direct investment through buying your own properties, such as a buy to let, or indirect investments, such as owning property company shares or making loans to property development companies.
Pension financial products are a form of long term investments, which are tax-efficient, but can only be used much later in life. Your employer, if you have one, may set up a pension for you, and you can also set one up yourself, called a SIPP or Self Invested Personal Pension. You can invest in stocks, shares, bonds, property and cash within a SIPP. We explain pensions in general in more detail here.
Derivatives are a group of advanced financial products, or financial instruments as they are sometimes known, that are based on a promise or contract with something else.
Two or more parties would enter into a contractual agreement, whereby they would base the value of the derivative on an underlying asset, such as a market index, stock, bond or commodity etc.
An example of a derivative in action is when an airline buys fuel months in advance, based on the price of oil today. They try and lock in what they think are low prices now, but the risk is, if the price of oil gets even lower, they have already fixed their fuel prices at an agreed level. Of course, if the oil price rises, they have secured a lower price for their fuel, at a predetermined point in the future.
FINANCIAL PRODUCT FACT: These sorts of derivative products, are sometimes called futures.