FOOL'S EYE VIEW
Obviously Great Financial Products

By James Carlisle
December 4, 2002

Finance is all about risk and reward and maximising your expectation of the latter against your requirements for the former. Bad financial products will spoil your balance by either reducing your returns without giving you less risk or by increasing your risk without giving you more return. I looked at the five worst products last month on just this basis.

Things aren't all bad, though, and some financial products have an efficiency that hits that balance of risk and reward bang on the head, making them fundamentally great products. Here's my top five.

Cash

It won't do you any investment favours over the long-term, but who said it needed to? Cash does what it says on the tin. If you fancy a pint, then handing over £2.75 will do the trick (just about, in central London, anyway). Handing over a couple of shares or a shrivelled up endowment policy won't, because the landlord won't have a clue what they're worth.

Cash, whether waiting patiently in the bank or sitting in our pocket, let's you know where you stand. At any point in time, you know how far your shekels will take you. You'd probably settle for that even if you didn't get any interest. The fact that they'll pay you a few per cent per year for your cash is just icing on the cake.

Index trackers

Index trackers turn being average into an art form. That's a good start, since being average is, quite literally, what reducing risk is all about. Trackers are designed to give you the average return of the stock market, or a defined slice of it. By doing that, they immediately cut out the risk of deviating from that average. Every other type of investment fund carries the risk of coming in below or above the market average, on top of the risk in what the market average does itself.

If reducing risk wasn't enough, trackers also operate more cheaply than other investment funds and these lower costs give them an advantage on the return front. So you've got minimised risk matched up with maximised returns and you can't say fairer than that!

Trackers come in the form of investment trusts, unit trusts, or exchange traded funds and you can wrap them up in an Individual Savings Account or a Stakeholder Pension. But whatever you do with them, trackers are a fundamentally fantastic product. There's more about them in our Index Tracker Centre.

Big Investment Trusts

Investment trusts are just companies that invest in other companies. So, by buying shares in the investment trust, you get exposure to a wide range of underlying investments. The important point in this is that with you being its shareholder, the investment trust has to put you first. That's not necessarily the case with other types of fund, such as unit trusts and OEICs.

The effect of this is that investment trusts have to keep their charges to a minimum, just as any company must try to keep its costs down. For the really big investment trusts, with assets of a billion pounds or more, charges become a tiny portion of the invested money -- often even less than the charges on an index tracker. Not only that, but because the shares are listed on the stock market, investors will typically price them at a discount to the value of their assets -- thereby negating some of the effect of the charges.

You won't necessarily get the market average from an investment trust, but perhaps you didn't want that anyway. There's a variety of them about, investing all around the world in all sorts of assets and that may be just what you want. If it is, then the really big investment trusts are a very efficient means of getting exposure to shares. Just remember that they're companies and you should research what they invest in and how they operate just like any other company.

Current Account Mortgages

Current account mortgages are a relatively recent invention. They work by tying together your current account, your deposit account, any personal borrowings and your mortgage. So, when some money goes into your bank account, it actually has the effect of paying off a little bit of your mortgage (or personal borrowings), immediately saving you interest -- at your mortgage rate of interest. Similarly, if you borrow some money, then it just gets added on to your mortgage so, subject to limits, you can borrow funds as required -- at your mortgage rate of interest.

The efficiency is given by grouping your different accounts together under one roof, so that you, and your bank, know exactly how things stand. The pay off is a higher rate of interest on your bank accounts and a lower rate of interest on any personal borrowings. You also have the flexibility of paying down your mortgage as quickly as you choose.

'Offset' mortgages are similar, but 'offset' the different accounts against each other rather than actually putting them all in the same pot. There's more about the whole genre, in our 21st Century Mortgage Centre.

Cheap, well-targeted, insurance

There's nothing like a bit of collective spirit, and insurance brings the power of the masses to the individual. We each, individually, can't afford to have our house burn down, or have a car accident, or have a long spell off work because of illness. But, by grouping together, we all pay a little bit towards the cost of our collective misfortunes. In other words, insurance makes us average and thereby reduces risk.

We have to pay insurance companies a little extra for all their hard work in grouping us together, thereby giving them a small profit (that's the idea anyway), but it's well worth it where there are risks that could otherwise have a devastating impact on our finances.

When buying insurance, the important thing is to get the right balance of risk and reward. That means only insuring against risks that you can't afford to live with (otherwise what's the point of giving the insurance company a profit) and shopping around for the cheapest product that matches your requirements. There's more about insurance in the Fool's Insurance Centre.

Any more?

So that's my list of the top five financial products. Have I missed anything out? Let me know on the discussion board.