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Let your cash grow with the market flow

WHO AMONG us can forget their parents' admonition: "You've made your bed, now you'll have to lie in it." I was reminded of this when Mary Nightingale came to ask me for advice on the stockmarket.

"What do you want to know?" I enquired.

Mary replied: "Well, on the surface my dilemma seems straightforward. I want to invest my capital. On the other hand I keep reading about the FTSE falling, recession looming and the Asian crisis. It's all so off- putting."

Mary was beginning to sound worried, so I tried to calm her down: "Look, only this week I met a couple who had the same feelings as you. Despite having a capital sum of lottery proportions they almost felt immobilised by the vast array of choices and the mixed messages they got from friends and so-called experts. So let's start by trying to define what we want this money to do.

"Grow," said Mary, with a smile.

"I was hoping for just a little more definition. How about choosing a point in time when you might want access to the money, bearing in mind you generally shouldn't look to invest any money for less than five years."

"Does that mean I can't get my hands on it if I need to?" she replied.

"Not at all, but as soon as you invest there is always the risk that it may go down in value, and, ultimately, what you get back will be heavily influenced by market conditions at the time," I advised her.

"That sounds quite frightening."

"Maybe, but there is no such thing as `risk-free' investment. Even if you put your money into a building society, you are still running a risk. It is the risk that over the years inflation might eat away the buying power of your savings."

My client said: "OK, when you put it that way I can see the point in having a spread of investments. But which ones?"

"Well, we have agreed that five years is a reasonable investment period, so next we need to identify where in the world you would like to invest."

"Not Japan," she replied hastily.

"OK, but we can be a little more scientific and measure how risk-averse you are, on a scale of zero to 10."

I then guided Mary through this scale, starting with zero equalling cash and 10 equalling China, Russia and similar types of highly risky markets.

"I'm getting the hang of this, said Mary cheerfully. "What's next?"

I replied: "Well, now we can start talking about your tax position and what it's likely to be in the future. We have to remind ourselves not to let tax be the tail that wags the investment dog. But we need to choose investments that are within the level of acceptable risk and are sympathetic to changing circumstances either personally or through changes in taxation."

Mary asked: "So I can split my investment up according to differing timescales, levels of risk and terms of investment?"

"Now you're getting it," I cried. "So if you want more of your money in low-risk investments for when the stockmarket is jittery, you simply need to invest in those areas between zero and four. When you think markets have settled, then choose to invest in higher-risk funds."

"How will I know when that time is?"

"This is where practice and theory part company. What you invariably find is that anyone can tell you with hindsight exactly when this moment comes. In the absence of such wisdom, the only way to proceed is to spread your capital around or have a "diversified portfolio", as it's known in the business. This sounds rather grand; in reality it simply means we should choose investments that don't duplicate whatever you have in, say, your pension fund or existing PEPs."

Mary said: "I like the sound of that approach, but what if I am still nervous of investing in a falling market?"

"We can begin by choosing `capital secure' and `guaranteed' products offered by companies like HSBC. This fund manager has a capital-protected PEP which allows you to invest up to pounds 9,000 in four stockmarkets around the world at very little risk."

"That sounds too good to be true," Mary retorted.

"Aye," I said in my strongest Yorkshire accent. "It is very true that you get owt for nowt these days, so next month we will look at the price you pay for such a guarantee."

Roddy Kohn is principal at Kohn Cougar, a firm of independent financial advisers, at Wellington House, Wellington Park, Clifton, Bristol, BS8 2UR (0117 9466384). Mr Kohn was also the author of `The Fixers' column on August 5