The Worst Ten Financial Products - Part 1

This week's article is based on a recent article by Neil Faulkner of The Motley Fool.

Over to Neil…

When you're shopping around for financial products sometimes you need to have your wits about you as by their nature they can be very complex.

How do you know you're getting the right deal from the (often) thousands available?

But that's not the biggest problem. The problem is that some of these products are useful for only a small number of people. If a product helps just a small number of people, its existence is justified.

However, if a product is very profitable it'll often be sold aggressively, and not just to the handful of people who would benefit most. That's why you can't say that the products listed here are unsuitable for everyone, but I certainly think that they are not suitable for the majority.

Anyway, here they are: the first 5 of the 10 worst products in no particular order (part 2 will follow in the next issue):

1. 'Guaranteed' Equity Bonds

I could have chosen a few different types of bonds to criticise, but Guaranteed Equity Bonds (GEBs) make the most frequent annoying appearances in my email inbox.

The idea is that your investment is tied to the performance of the stock market. After a fixed period, usually five years, you get your money back plus any increase in the market. Sometimes they'll even offer, say, an extra 10% of the increase. If the stock market has fallen at the end of the period, you still get all your initial investment back. That's the guarantee.

On the surface this sounds great, but in reality it's pretty shabby. Firstly, with GEBs you get any capital gains from the market and sometimes even more, but you don't get the dividend income. Each year, many listed companies pay out a dividend, which can be reinvested. Compounded over five years this could quite easily mean a gain of 20% or more. With Guaranteed Equity Bonds, you get none of this.

Secondly, your money is locked in for the whole period, so you don't have the flexibility you get with other investments.

Thirdly, guaranteeing that you get your money back is not much of a protection. Over the five years your money will have been eroded significantly by inflation, meaning, in real terms, you will get less money back than you put in. If you need a real guarantee, you should put some or all of your money in a decent savings account instead, which should keep you ahead of inflation and keep your money flexible.

Fourthly, negative five-year returns are very infrequent. 123 of the 131 rolling five-year periods from 1869 to 2004 have provided investors with a positive result. So why not stick with a simple, tax-efficient shares ISA?

2. The Payment Protection Racket

PPI protects your loan, mortgage or credit-card repayments against sickness, injury or unemployment. It sounds good in theory, but these policies are so littered with exclusions as to make them worthless to many people. Plus, if you buy your insurance from your lender, it's usually vastly over-priced.

3. Poor Store Cards

Store cards are another poor product, if used badly. It's all very well if you sign up to get the initial discount, but consider why retailers offer this to you? It's because they know that many shoppers will leave the balance on there for more than a month, so they can charge interest at incredibly high rates, often around 25%. If you get a store card for the introductory discount, pay it off straight away and never use it again.

4. Not-So-Secure Loans

Every time I've looked at a case to see whether someone should get a secured loan, I have always found a cheaper, better alternative. These loans are supposed to be good for people with high incomes, because it allows them to borrow more than £25,000, which you can't do with unsecured loans. However, you have to ask yourself if borrowing that money will really make you happier.
 
Often the answer will be no.

That's why many people say that these loans are more suitable for poorer or more indebted people, as it can be seen as a way to consolidate debts. However, research has found that, five times out of six, people taking out these loans go on to rack up more debt.

Keith Tondeur, national director of the money education charity Credit Action, said that for the people who contact them with serious debt problems, secured loans are only suitable 3% of the time. We're not talking about 3% of the population here, we're talking about just 3% of people on the edge of insolvency. That's no more than 60,000 people.

5. The No-Deal Mortgage

There are thousands of mortgage products out there, but in 'How Long Should You Fix Your Mortgage For?' I suggested that there are basically two different types of mortgage: The Deal and The No-deal. It's a little simplistic, but a good guiding rule.

If you have a deal, such as a tracker or a fixed-rate mortgage, so that you're paying close to the Bank of England's Base Rate, then that's great. However, if your deal has expired and you're paying your mortgage company's standard variable rate (SVR) then you are paying way over the odds for your laziness, probably thousands more each year.

Based on an article By Neil Faulkner | 17 April 2007

The Financial Tips Bottom Line

- any investment product with guarantees eats into your possible profit
- product protection and warranties are poor value
- store cards - pay them off straight away
- on any deals on your mortgage ensure you are not left in their standard rate
  when the deal ends
- only buy what you understand

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ACTION POINT
 
No doubt you're busy and have a 'to do' list that never seems to, well, get done.

If you can't find the time to ensure you have the right financial products and policies in your portfolio then why not pay an expert to do the work for you?

Failing to do so could mean you're wasting money every month through pure ignorance.

As Neil says, 'let Fools beware'!