Tracker funds are one solution. These mirror the performance of the stock market as a whole through investing in all or most of the shares that make up either the FTSE 100 or the All Share index. This means that they are fully diversified and do not have to rely on any particular sector of the market.
Trackers also remove the chance of choosing a poor-performing fund. Statistics show they do better than most actively managed funds where the managers make their own stock selection.
But while they may reduce the risk of picking a poor performer, trackers are still equity investments. If the market falls, so will the value of your investment.
Ian Millward, investment marketing manager at the independent financial advisers Chase de Vere, warns: "Don't go into a tracker thinking you're buying a no-risk investment. Trackers are stock market investments and so are not without risk. But if you're going into equities, they are one of the lowest-risk ways of doing this."
Many management groups now run tracking funds, including Direct Line, River & Mercantile, Fidelity, Legal & General, HSBC, Gartmore and Virgin Direct.
For those who cannot afford to lose any of their capital, protected personal equity plans (Peps) are a good option. Typically run for a fixed period, at the end you will receive a share in any growth in the stock market, but if it has fallen during this time, you are guaranteed to get back your original capital.
HSBC is one of the few companies to offer this protection. Its Pep Protector is available until mid-February, and runs for two years. If the market falls during this period your capital is protected, but if it rises you get the full growth up to a maximum of 20 per cent over the two-year term.
Alan Gadd, managing director at HSBC Investment Funds, says: "This PEP gives you peace of mind plus a piece of the action. Clearly there's a cost for the protection. You won't get any dividend income and your capital return is capped at 20 per cent for the two years."
Alternatively, you could consider unit trusts with a "floor price" which the units are not allowed to fall below. These are offered by companies such as AIB Govett, Scottish Widows and Edinburgh Fund Managers.
They are complicated investment vehicles. AIB Govett's Safeguard unit trust, for example, offers quarterly protection of 98 per cent. If the market rises during the three months, holders share in the gains, but if it falls, investors are assured of getting back 98 per cent of their original capital. This 98 per cent protection level is reset every quarter.
With all these funds, you should look closely at the charges to see if the protection is worth paying for.
Another option for the cautious investor seeking growth is guaranteed equity bonds, where the returns are linked to stock-market performance with no risk to your original capital. These bonds are currently offered by Alliance & Leicester, Birmingham Midshires Building Society, Bristol & West, Britannia Building Society, Midland Bank Offshore, Nationwide Life, NatWest Bank and TSB among others.
The guarantees and possible returns on these bonds vary enormously. For example, Birmingham Midshires Building Society's 51/2-year ELSA Tracker Bond pays the greater of either 100 per cent of the growth in the FT-SE 100 index or a 20 per cent bonus on maturity.
Other bonds may only guarantee to return your original capital at the end of the term, but may offer more than 100 per cent of the market's growth if it rises. In general, the more protection you are offered the lower the potential rewards will be.
Another option for investors is with-profits bonds, offered by leading life insurance companies. Every year a bonus is paid, which you can reinvest for further growth or take as income. A terminal bonus may also be paid when you come to cash in the bond, often worth the equivalent of up to another 2 per cent a year. The insurers can impose heavy penalties if you cash in during the early years.
At the moment, annual bonuses on with-profits bonds are running at between 6.5 per cent to 7.5 per cent a year, with no tax to pay on them, but non- taxpayers cannot reclaim tax already paid by the funds.
HSBC 0800-262115; AIB Govett 0845-3009090; Birmingham Midshires 0645-720721.Reuse content