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.
These accounts 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 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 accounts available, but they all have the same overall purpose, of increasing your money by the payment of interest, in a safe and secure 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 savings accounts are:
Easy access – These 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 accounts 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 accounts 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 cards 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 below.
The dangers of credit
Fortunately, you cannot get a credit card until you are 18, but unfortunately, simply being 18 doesn’t mean you are financially literate enough, not to fall for the credit card debt trap.
The simple fact is, banks are in the business of making money (profits), and credit cards provide huge sums of money for banks, by consumers (you and I), who get themselves into debt using credit cards.
It is easy to get a credit card as soon as you are 18. It is also easy to find things, and “stuff” to buy, using your new “magic card”, which will allow you to spend the bank's money, at the speed of lightning.
New phone, ka-ching, new laptop, ka-ching, new clothes, ka-ching, coffees, cinema, restaurant, a round of drinks for everyone, and another! You get the idea.
It is incredibly easy to get carried away with your new-found credit card friend, it quite literally will never say no, until you have reached your credit limit that is, which could easily be £5,000!
Once you have had your spending spree and the fun subsides, on the 1st day of the following month, your credit card statement will come through, showing you both how much you have spent of the bank's money, and also how much extra they want back in return. Don’t think for a second that banks charge the same interest for you to borrow their money, as they are prepared to pay you for your savings, oh no.
You may only earn 1% or 2% on your savings, but they will charge you much, much, more, probably somewhere in the region of 15% - 25%, and possibly even as high as 30% or 40% in some cases.
Many people have taken years and years to get out of the debt trap created by credit cards, and some people, unfortunately never do get out of debt. These people were not financially literate and did not understand how the system works. You, on the other hand, will be financially literate after reading this website and will understand the dangers of credit.
So in summary, unless you know how to use a credit card to your own advantage, i.e. use the bank's money for free, and never ever pay them a penny in interest, then I would strongly suggest, you stay away from credit cards, and throw the numerous offers you will get from the banks, straight in the bin!
FACT: New students are deliberately targeted by banks, keen to offer them credit cards for their increased spending habits away from home.
These loans can be either secured or unsecured. A secured loan means the bank has secured the money it lends you, on either the item you are buying or some other item of value, known as collateral.
Secured loans should charge a lower interest rate than unsecured loans because the risk of the bank losing its money is lower. This is because if you can’t pay the secured loan off, they will take the goods secured against it, sell them, and get their money back that way.
Unsecured loans are more expensive, as the banks would lose their money if you didn’t pay back the loan, and they couldn’t force you to make payment any other way.
Financially literate people understand how loans work, and try to avoid using them if at all possible. They know they will always end up paying back far more than they originally borrowed, once the bank's interest is added.
To make it easier to compare the cost of different loans, loan companies have to publish a % figure known as the APR or Annual Percentage Rate. This should show you how much the loan will cost in total, including any setup fees or hidden charges. The lower the APR figure, the better it is for you, if you really must borrow. A loan with an APR of 2.99%, is far better value, than a loan with an APR of 9.99%. The difference can be subtle, but it's significant.
A mortgage is the name given to a large secured loan for the purpose of buying property. This is really the only type of debt I would suggest you take out, as it is practically impossible for anyone other than the super-rich, to buy a house or flat without some sort of financial help by way of a mortgage loan.
Interest rates on mortgages will be higher than the interest rates you can get on your savings accounts, but lower than personal loans. This is because the loan is secured against your property, and if you fail to pay the loan back, the banks can and will take your house, sell it, take what they are owed, plus some extra fees of course, and give you back anything that’s leftover. This is called a repossession, and you must avoid this at all costs.
Mortgage interest rates are usually pegged to the Bank of England base rate, so this is a key part of both mortgage and house affordability. UK and worldwide interest rates have been comparatively low for the last decade or so, following the financial crisis, and therefore mortgages have been available in the 2% - 5% range for most people.
This hasn’t always been the case. My very first mortgage deal was set at a whopping 15%! And that included a 1% special discount for the first year only. This rate seems quite extreme now, but at the time, in the late 80s, the Banks base rate was running at between 12% - 15%, and so this was quite a “good” deal.
These high rates are not likely to return any time soon, but the fact remains, they did happen, and so could happen again at some point in the future.
FACT: The word mortgage means “death pledge” in old French and Latin. This could be interpreted as owing the debt until death, although mortgage terms are more usually 25 to 30 years nowadays.
Your credit score
Financial institutions providing mortgages and loans, will look at, and consider your credit score when you apply to borrow money from them. This score, which is quietly and secretly being calculated in the background on you, by the rating agencies, is very important if you do want to borrow money at a reasonable rate, and certainly essential if you ever plan to be a homeowner in need of a mortgage.
Rating agencies use slightly different rating systems, but the general principals are all the same. Low scores or the red band indicate a poor risk for the banks. Medium scores or an amber band indicate a medium risk. High credit scores or a green band indicates a good risk for the banks.
Unsurprisingly, good risks are offered loans with better rates, whereas poor risks will either be declined outright, or have to pay a higher interest rate to compensate the banks for the increased risk of default.
To build a good credit score, it is important to pay back all loans on time and in full. This includes credit you use with catalogue shopping or in-store cards, plus any other buy now pay later deals you take on. If you don’t pay back money owed or are often late in paying back instalments, then this is recorded and adds to a negative score with your credit rating.
TIP: You can usually find out your own credit score, by asking the rating agencies such as Experian or Equifax directly.
Although not sold by banks, it is worth mentioning payday loans just quickly, as these are the most expensive loans of all.
The interest rates can be eye-watering and can run into the hundreds of per cent per year. Indeed, a few years ago, some of these firms APR’s exceeded 1,000%. The regulators had to bring them into line!
Although these loans are marketed as just being for the short term, so from one month to the next, the only advice I can give you about them is, DON’T DO IT. NOT EVER!
Insurance is simply a way of financially protecting a specific item of value to you. You pay a fixed sum of money, known as an insurance premium, and in exchange, the insurance company will pay you back, either a sum of money if your item of value is lost, damaged, broken or stolen, or they may replace the item itself with another one.
Why do I need insurance?
You may need insurance if you have bought an expensive item, such as a new iPhone or laptop, which you wouldn’t be able to replace straight away if something happened to it. You might consider that paying say £20 per month, is good value for the peace of mind it gives you, knowing that if your £750 laptop was lost or stolen, you would get a replacement.
The cost of that peace of mind is of course, the £20 per month that you are spending on premiums. If you don’t lose or break your laptop, and never need to make a claim, then those insurance premiums have gone.
There are many different types of insurance products for all sorts of items of value, different times of our lives, and different ages. A few examples are shown below:
Motor insurance – is compulsory if you drive a vehicle on the roads.
Breakdown insurance – may be useful if you drive, and your car breaks down.
Gadget insurance – covers the cost of repairing or replacing common electrical gadgets, such as phones, laptops, iPads, computers, gaming consoles etc.
House insurance – protects your home in case of fire, flood or other damage.
Health insurance – covers the cost of private medical treatment, if needed.
Critical illness insurance – provides a lump sum, or income, if you are diagnosed with a serious life-threatening illness.
Life insurance – provides those you nominate, with a lump sum of money, if you die.
All insurance products have a policy document, which sets out the rules. You need to read this very carefully, to understand what you are covered for. There are always exceptions and exclusions, and maximum payout amounts, and it’s up to you to make sure you get the right cover for your own needs.
For example, if you want to cover your new £1,000 iPhone, whilst on holiday in Spain, there is no point in buying an insurance policy which has a maximum pay-out of only £200, and also excludes any damage or loss outside of the UK.
Insurance can be a very useful tool on your journey to financial freedom, but it can also be complicated. You may wish to use the help of an insurance expert, such as an insurance broker, when the time comes for you to consider such things.
Some years ago, I was thankful for taking out landlords insurance, when a tenant of mine decided to stop paying his rent, and then refused to move out. Landlord and tenant laws are quite strict in the UK, and it is very important you get the legal process correct, or it can cost you dearly. Thankfully, the insurance company dealt with all the legal proceedings and paid for them, and I eventually managed to evict the defaulting tenant, some three months later. This is a good example of insurance protecting an “asset”, and responding when needed.
TIP: If you still live at home, many of your gadgets should be covered under any household insurance policy that has been taken out, so there is no need to buy a separate policy.
We will cover investments in more depth here, but for now, a brief overview of some of the main types of investments 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 investment bonds, 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.
Pensions 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.
FACT: These sorts of derivative products, are sometimes called futures.