FOOL'S EYE VIEW
Five Frightening Financial Products!

By Cliff D'Arcy
October 26, 2004

The UK is absolutely awash with dreadful financial products.

According to independent financial researcher Moneyfacts, we can choose from around 8,000 different mortgages; 1,500 savings accounts; 400 credit cards and 150 personal loans. Blimey, with this vast array of choices, it's no wonder that so many of us can't decide what to do with our money!

Of course, while a few of these products qualify for the prized honour of being a Best Buy, most are mediocre or, even worse, complete rip-offs.

These five products are about as far from being Best Buys as it's possible to be:

1. Baby Bonds®

These are heavily promoted to parents and other relatives as the ideal investment vehicle for children. However, I think they're one of the worst savings plans that money can buy.

Here are the pros and cons of these Bonds:

Pros:

• They are tax-free savings plans, which means that payouts aren't liable to income tax or capital gains tax.

That's it. I can't think of anything else to support these Bonds!

Cons:

• They are with-profits endowment policies, and we all know how badly these have performed in recent years, don't we? Eek!
• They guarantee to pay out a minimum lump sum on maturity, but this guarantee is largely worthless, as the minimum payout is always much less than you've paid in!
• Their charges are gobsmackingly high. If you pay in £25 a month for eighteen years, your total investment comes to £5,400. If your fund grows at 9% a year, you'll pay £2,786 in charges, which comes to more than half of your total investment (a whopping 52%). Yikes!
• They pay generous commissions to financial advisers, which increases the possibility that advisers will recommend them over cheaper, simpler investments that pay little or no commission.
• They are inflexible: you have to save for a minimum of ten years to make them work – and you can't reduce your payments or withdraw any money along the way.

So, when you spot a Baby Bond brochure in your Bounty pack in the maternity ward, use it to line the bin. I can't see a single reason to recommend these regular-savings plans to parents and other relatives. Instead, read A Great Man's Advice On Saving for information on cheap, simple, flexible alternatives.

Check out our Savings and ISA centres.

2. Old-style mortgages

Modern 'flexible' mortgages are pretty funky.

They allow you to overpay, underpay, take repayment holidays by skipping repayments, and withdraw or deposit lump sums. Of course, making regular overpayments or dropping in the odd lump sum can seriously reduce your interest bill and shorten the life of your mortgage. Tasty!

What's more, with a flexible mortgage, your debt falls as soon as repayments hit your account. In other words, these loans calculate and charge interest daily. On the other hand, millions of borrowers have outdated 'annual interest' mortgages (also known as 'annual rest' loans). With these, repayments (and most overpayments) are only knocked off your loan at the end of each year. So, your January repayment isn't credited until, say, December. Hence, every repayment that you make is effectively an interest-free loan to your lender!

So, if your mortgage is a few years old, ask your lender how interest is charged – and then demand a fairer deal. At the same time, threaten to take your loan elsewhere unless your lender gives you a lower rate. That way, you upgrade your mortgage and reduce your rate at the same time!

Check out our range of Mortgages and 21st Century Home Loans.

3. Shabby savings accounts

British savers have around £500 billion on deposit (that's a '5' followed by eleven zeroes!), which is roughly half our total debt of £1,024 billion.

Sadly, a big chunk of this money mountain is rotting away in obsolete accounts that pay a pittance in interest. Hundreds of big-name accounts are paying as little as 0.1% a year on your savings, which amounts to a measly £1 per £1,000 per year.

That's a crying shame because, with as little as ten minutes spent finding a Best Buy, you can increase your interest rate to, say, 5.5%, which means fifty-five times more interest! It's time for you to Supersize Your Savings today!

We have seven accounts paying 5%+ in our Savings centre.

4. Guaranteed Equity Bonds (GEBs)

I've never bought one of these stock-market investments – and I doubt that I ever will.

GEBs are marketed as a 'halfway house' between the security and low returns of cash deposits and the higher risks and returns of investing in shares. Most tie up your money for five years, with your return linked to the performance of one or more stock markets or 'baskets' of shares.

Many cautious investors are attracted to GEBs because they offer 'downside protection'. In other words, you don't lose any money if the market falls over the five-year life of your investment. However, GEBs are a lot less than they're cracked up to be, for the following reasons:

• You only get the index return – the capital growth. In other words, you don't receive any of the income generated by the underlying shares. In the UK, this is worth, say, 3.2% a year at the moment. Over five years, this income compounds up to a sixth (17%) of your initial investment. That's a lot of money to give up for downside protection that you may never need!
• The UK stock market has rarely fallen over five-year periods (with income reinvested). In fact, in the 130 five-year periods since 1869, this has happened only seven times. So, your historical chance of losing money in shares over five years is about 1 in 19, or 5.4%. But many investors have been scared away from shares since the turn of the Millennium, because two of these seven negative periods occurred recently (in 1997-2002 and 1998-2003). This smells like Recent Event Syndrome! 
• Inflexibility: your money is locked in for five years, so you can't withdraw any of your initial investment, nor can you add to it. If you're a patient investor, why not take the full risk -and potentially greater returns - of the stock market for real?
• Thanks to inflation (rising prices) at, say, 2% a year, your money would be worth about a tenth (10%) less after five years, assuming you got back only what you put in. If you're going to beat inflation long-term, a good bet is to invest directly in shares via a cheap investment vehicle.

As with almost all financial products, GEBs are sold to make their providers a 'guaranteed' profit. Give them a miss.

If you can't take risks with your capital over five years, stick it in a tax-free savings account. If you can – or you're playing a longer game – try a cheap, simple index tracker.

Visit our Tax-Free Savings and Index Tracker centre.

5. Traditional bank accounts

The vast majority of Brits have a decidedly inferior bank account. Traditional bank accounts pay credit interest of a paltry 0.1% a year and charge, say, 20%, interest on overdrafts.

One thing that puts off many people from switching bank accounts is the fear of administrative nightmares while switching.  However, banks have become much better at transferring accounts, thanks to a tougher Banking Code.

Replacing your conventional bank account with its modern heir could mean earning up to 55 times as much credit interest and paying much less in interest and charges – even nothing – when you're in the red. Why earn £2 a year interest, when you could get £110? Learn more in The Perfect Bank Account.

Head for our Banking centre.

So, that's our frightful five. I could have made this list into a terrible ten, or even twenty, but I shall hold something back for another day. Good luck with getting rid of these dreadful old dogs!

More: Find better investments, mortgages, savings and current accounts.