A PEP is best suited to taxpayers, especially higher-rate taxpayers. This is because until April, when PEPs are replaced by individual savings accounts (see article below), investments within a PEP are free from income and capital gains tax.
After 6 April the tax rules for share dividends will change. Until then, PEP managers will be able to reclaim the 20 per cent advanced corporation tax (ACT), which is basically the tax paid by companies on the dividends they distribute to shareholders. For the next five years, only half the ACT will be reclaimed for PEP holders and from 2004 you will get no tax rebate at all. Income from equities will no longer be tax free.
This change will affect all companies paying dividends. The better news is that companies geared to fast growth do not pay large dividends.
Everyone is allowed to put up to pounds 6,000 in a general PEP and another pounds 3,000 in a single-company PEP.
Husbands and wives have separate PEP allowances, so this means that a couple can invest up to pounds 18,000 before the end of the tax year.
You can pick individual shares that you think will grow in value over the years and put them into a self-select PEP, but if you are new to the stock market you should choose one of the plans now offered by more than 100 fund management groups. These invest in unit or investment trusts that allow you to share in well-diversified portfolios run by professional managers.
You can put up to the maximum amount in any fund that invests in the UK or the European Union. If you want a fund that has more than half its investments outside the EU, you can only invest up to pounds 1,500.
"If you want out-and-out growth," says Kim North, an independent financial adviser at Pretty Financial, "you could look at some of the smaller funds. But as these can be very volatile you may want to concentrate on the big fund management names. Make sure the aims and investment philosophy of the fund concur with yours."
If you do not already have a PEP, you should consider "a large, mainstream fund that invests in large British companies", advises Graham Bates, of Bates Investment Services. "Look for a good solid name with a good performance record. If you already have PEPs that invest in the UK then look to diversify into European funds. While you should look at charges, performance is more important. Try to pick a fund that does consistently well year in, year out."
Mr Bates' research found that only five funds in the top 30 PEP performers for the five years to 1993 are still in the top 30 for performance over the last five years. These funds are Fidelity European Opportunities, Royal & SunAlliance European, Scottish Widows European, Lazard European and Jupiter Income.
You should also review your growth portfolio annually. Investment fashions change as often as fund managers, and a fund that you Pepped six years ago could have changed significantly for the worse.
We will be in a low-inflation, low-interest rate economic environment for the foreseeable future, so you should look for overall growth - don't ignore income. Some income funds, such as corporate bond funds, will have a home within your growth PEP and ISA portfolio. You don't have to take the income as most of them allow you to reinvest it and use it to buy extra units. This will have the effect of compounding any underlying growth.
Many independent financial advisers pick growth funds that take a bottom- up approach - the managers choose the companies before they look at the sectors or countries where they are based. UK and European funds run by groups such as CGU, Fidelity, Invesco, Jupiter, Gartmore and Newton fall into this category.
If you are worried about getting your timing wrong or nervous about the direction the market is heading, you could consider making regular payments into a fund. As the end of the tax year approaches, most PEP managers will only accept lump sums. If you can set up a regular investment plan you can convert it to an ISA in April at no extra cost and carry on paying into the fund. By putting money into equities on a regular basis you will smooth out the highs and lows in the market.
Contacts: Bates Investment Services - for a performance review pack for your PEP portfolio, call 08000 688655.