FOOL'S EYE VIEW
Your Financial Jargon Buster

By Cliff D'Arcy
September 30, 2004

Before joining the Fool, I spent fifteen years working for a string of financial services companies. From day one, I discovered that financial companies love to talk in a language of their own creation. Given the choice of English or gibberish, financial firms choose to spout utter nonsense!

In my ten years in marketing roles, I tried to do my bit to hold back this tide of gobbledygook by writing in a style that made sense to customers. After all, your chances of selling something improve dramatically when potential customers fully understand what's on offer!

My experiences weren't entirely painful – after all, they gave me the skills I needed to become a financial writer. However, 99% of financial firms could do better when it comes to translation. So, without further ado, here's my guide to interpreting the language of money:

AER (Annual Equivalent Rate); EAR (Equivalent Annual Rate)

Some savings accounts pay interest once a year, others pay monthly or quarterly interest. The AER shows the 'true' annual interest rate if you leave all your interest in the account and allow it to compound.

AIM (Alternative Investment Market)

A stock market for small companies, which is much smaller than the London Stock Exchange. Shares listed on AIM may be riskier and less liquid, which means that large amounts may be hard to buy and sell.

AMC (annual management charge)

The annual fee charged by your friendly investment fund manager. This can be under 0.5% for the cheapest funds and 4% or more for the most expensive. Note that many funds also have other sneaky hidden charges, so don't just compare annual management charges! Instead, check the TER (total expense ratio) which includes administration, trustee and audit fees as well.

Annuity

An income paid to you when you retire. You hand over a slab of money to a life assurance company, which promises to pay you an agreed income until you die. The longer the company expects you to live, the lower your annuity will be. Don't die too soon, because you lose all the capital when you go!

APR (Annual Percentage Rate)

A way of showing how much borrowing money will cost, expressed as a percentage, such as 6.9% APR. APRs should take account of all charges for credit, but they are not foolproof. For example, the APR doesn't change when a lender adds rip-off payment protection insurance to your loan!

AVC (Additional Voluntary Contribution); FSAVC (Free-standing AVC)

Extra payments into your pension, over and above what your employer asks you to pay. Free-standing AVCs are not paid into company schemes; instead, they go into an investment managed by a pension company. In the past, many FSAVCs have performed badly, thanks to disappointing investment returns and sky-high charges.

Bank of England Base Rate

The Bank's Monetary Policy Committee (MPC) sets a base lending rate aimed at helping the government meets its inflation target. The cost of variable-rate loans (such as mortgages or business loans) usually rises when the base rate goes up. When the Bank hikes its base rate, borrowers are sad, but savers are happy. When it goes down, borrowers are happy, but savers are sad. The Bank can't win, can it?

Bid-offer spread

This is the difference between the price at which you can buy shares (the 'offer') and the price at which you can sell shares (the 'bid') at any particular time. The buying price is always higher than the selling price. For small companies or shares that are traded infrequently, this spread can be 10% or more. Ouch!

Blue chip

One of the UK's biggest companies, which are usually considered to be a safer investment than smaller firms. Usually used to refer to members of the FTSE 100. The term comes from the high-value blue-coloured chips used in casinos.

Bond

Bond investors are usually seeking fixed incomes. They hand over their money to a business, which, in turn agrees to pay them a fixed rate of interest. Government bonds are known as gilts; company bonds are more risky, as you are effectively giving the company (such as Tesco or BT) an IOU, which may not be repaid.

Financial firms also used bond to describe other medium-risk investments, such as guaranteed equity bonds (GEBs). Some of these products have turned out to be real dogs, so choosing the wrong bond can be as painful as other forms of bondage!

Broker

A person who sells financial products, such as insurance policies or pension plans. A stockbroker is a middleman who makes a living from the money earned when you buy or sell shares. The 'broke' part worries many people!

Capital

What well-off people call a pile of money!

Capped

Something that won't rise above a certain limit, or cap. For example, a capped-rate mortgage of 6% means that a borrower will never pay more than 6% for this loan.

CAT (Charges, Access and Terms)

If a financial product is CAT-marked, it meets the government's benchmarks for charges (no more than 1% a year) and doesn't have any nasty surprises hidden away in the small print. CAT-marked products haven't really taken off, because financial firms prefer to sell more expensive and confusing products to take more of our money!

CGT (Capital Gains Tax)

A tax paid on the profits you make from investing, for example, in shares. You only pay CGT when your gain exceeds a certain allowance (£8,200 for the 2004/05 tax year), but you don't pay CGT on gains inside PEPs and ISAs.

Commission

Money paid to individuals or companies when you carry out financial transactions. History suggests that high commissions lead to poor returns – and to mis-selling scandals!

Dividend

Cash (or, occasionally, shares) distributed to shareholders. You get interest on your savings, so companies have to pay you dividends in order to make it worth your while investing in their businesses.

Endowment

A terrible product that combines expensive life insurance with a poorly performing investment. Also referred to as with-profits policy. Avoid like the plague!

Equity

What City types call a share. It's also the slice of your home that you own (the difference between its value and your mortgage).

ETF (Exchange Traded Fund)

A cheap way to buy into the stock market. ETFs are shares that track an index, such as the FTSE 100. One of the most popular is the iFTSE100 (LSE: ISF). You can read why I like ETFs here.

FSA (Financial Services Authority)

The regulator responsible for managing the conduct of firms and individuals involved in investment activities. Note that the FSA takes over the regulation of mortgages on 31 October this year.

FTSE (Financial Times/Stock Exchange)

FTSE provides indices for a number of international markets. In the UK, the most well-known indices are the FTSE 100 (the 'Footsie', tracks the value of the UK's hundred largest listed businesses), the FTSE 250 (big firms number 101 to 350) and the All-Share, which includes around 700 firms.

Gross

What you get before tax is taken off. For example, gross interest is only paid to non-taxpayers or holders of tax-free investments. Also a word that young children love to use!

IFA (Independent Financial Adviser)

A person who is licensed to give you advice on the financial products offered by a wide range of companies, not just a single provider. Fee-based advisers are a safer bet than IFAs who earn their living from commission, as the temptation to sell high-charging products can be too great.

Index

A measure of the value of a group of shares or an entire stock market. See FTSE.

Inflation

Rising prices cause the value of your money to fall over time. This effect is known as inflation.

ISA (Individual Savings Account)

An ISA is simply a wrapper placed around an investment (such as shares, bonds or cash) to protect it from tax. You can shelter up to £3,000 of cash in a cash mini-ISA (see this article on savings accounts) or up to £7,000 in shares. Learn more in our ISA centre.

LSE (London Stock Exchange)

The biggest stock market in the UK and one of the largest in the world. The total value of the shares of companies listed on the LSE comes to almost £1.4 trillion.

MIP (Mortgage Indemnity Premium); MIG (Mortgage Indemnity Guarantee)

A sneaky fee levied by mortgage lenders! Lenders are wary of lending you more than three-quarters (75%) of the value of a property. If you borrow more than this, some will charge you a MIG. This is an insurance premium that protects your lender if you default on your loan, but has absolutely no value to you whatsoever. You pay the premium for a policy that protects your lender!

These days, many lenders do not charge MIGs on loans of up to nine-tenths (90%) of the value of a property, known as "90% LTV (loan to value)". Thus, if you have a 10% deposit or own at least a tenth of your current home, you should be able to avoid paying this charge, which can amount to thousands of pounds.

OEIC (Open-Ended Investment Company)

Pronounced 'oik'. This is an investment fund that many investors prefer to a unit trust because, unlike unit trusts, OEICs do not have a bid-offer spread. In theory, an OEIC's charges should be lower than a unit trust's.

PEP (Personal Equity Plan)

The forerunner of ISAs, PEPs were available from 1987 to 1999. Even though they were withdrawn over five years ago, investors still have billions of pounds stashed away in PEPs, safe from the taxman's grasp. Learn more here.

Redemption penalty

A fine for not doing what a financial firm wants. For example, if you pay off your five-year fixed-rate mortgage in year three, expect to be walloped with an 'early redemption penalty'. Wherever there's an opportunity to fine customers in this way, financial firms are only too happy to oblige!

Share

A stake in a company. Buying even a single share in a company gives you part-ownership of that firm. Shares allow you to benefit from a company's success, which usually includes being paid dividends and having the right to vote on company matters.

SIPP (Self-Invested Personal Pension)

A type of personal pension. With a SIPP, you have full control over where your contributions are invested. A product that's ideal for experienced investors who don't want to hand over their money to a tired old pension company! Learn more in our SIPP centre.

Stakeholder pension

A simple personal pension that should offer reasonable value for money, as it must follow certain government standards – a bit like the CAT standards. I contribute to the Fool's stakeholder pension scheme – here's why.

Stamp Duty

A tax you pay when you buy shares (0.5%, which comes to £1 for every £200 invested) or property (1% to 4%, depending on the value of the property).

TAR (Total Amount Repayable)

When you're looking for a loan, APRs don't reveal the whole picture. You're much better off comparing TARs, which reveal the total amount that you're expected to repay, including all monthly repayments, fees and charges. All other things being equal, the lower the TAR, the better the deal. Easy peasy!

Tax

People grumble about paying tax, but it helps to support an entire nation. The more you earn and spend, the more tax you pay. As one friend of mine puts it, "You only pay tax when you're winning!".

TESSA (Tax-Exempt Special Savings Account); TOISA (TESSA-Only ISA)

More tax-free shelters for your cash. The last TESSAs (five-year tax-free savings account) matured on 5 April this year. Many TESSA holders have rolled over their capital into a TOISA, which keeps up to £9,000 away from the taxman). Learn more here.

Tied agent

A financial salesperson that sells the products of a single company. Avoid. The best thing to do with a tied agent is to tie him/her up and run off!

Unit Trust

A collective investment that pools investors' money, managed by a professional fund manager. Over the long term, most unit trusts don't beat their particular index, partly thanks to high charges. Unlike OEICs, units in a unit trust have a bid-offer spread, which means more charges for customers!

Yield

The annual income provided by an investment, expressed as a percentage. For example, an annual dividend of 20p on a share worth 400p means a yield of 20/400 = 5%. The yield on a savings account is the annual interest rate.

There, that wasn't too difficult was it? Give yourself a pat on the back for making it this far, plus a few more if you knew every term in this jargon buster!

Finally, If you'd like me to explain a financial term that I've missed, click on the feedback link below, and I'll do my best to oblige...

More: Check out our financial Glossary | Five Things Every Saver Should Know.