There are as many different types of financial service and products around as the human imagination can think of. Where there's a way to make money, people will figure out ways to market the idea. Add to that the complication that if one company can do it, then so can every other company and possibly offer a better deal besides, and the financial services industry begins to look like a jungle.
Luckily, things aren't as complex as they seem. Almost all financial services and products effectively do one of three things. Either:
- You lend somebody money for a time, they use that money to make more money, and they give you a share of the profit.
- You borrow money from somebody for a time, you pay them back in some agreed way, and they charge you for the use of the money.
- You buy something at one price and sell at another.
The key to choosing which of these products to use is in gauging the amount of risk you are prepared to take, how long you are prepared to wait for the pay-off, and how to make the process more efficient.
In general, if you are prepared to take more risk, you may reap better rewards. Of course, you may also lose out more. Most forms of financial product are a gamble to one degree or another - it is up to you to identify your attitude to risk and choose an appropriate product. A bank current account is very low risk, as you will always get out at least as much as you put in. In the case of investments, however, the risk is much higher, and you may end up getting back less than you put in. In a worst-case scenario, you may lose everything you put in.
As a general rule, the longer you are prepared to wait for your pay-off, the higher your reward will be. Longer term investments will generally be a better bet than short-term investments - savings mechanisms will accrue interest faster with compound interest and investment mechanisms will be able to weather short-term fluctuations in the market.
A word of caution though - this is a general principle, not set in stone! Long-term, low risk investments can still turn sour, and we have famously seen in the press recently how long-term low-risk savings plans such as final-salary pension schemes can go wrong. Even savings mechanisms rely on investment to generate the interest, and so are dependant on the market.
Often the key differentiator between one product and another is how efficiently the operation works. This is how one bank account can afford to offer you a better interest rate than the next. Clever ways of making the money work harder can also make the difference.
Part of your financial planning should be to identify your attitude to risk, and to determine what kind of timescale your goals in life give you to work in. Once you have done this, you have already gone a long way to defining what kind of product would suit you best.
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