How to save as you study

Investment Masterclass

Nancy and Mark Campbell. Ages: Both 34. Occupations: Linguist and full-time student

Nancy and Mark Campbell. Ages: Both 34. Occupations: Linguist and full-time student

Nancy and Mark are married but do not have any children. Mark's course finishes next summer, when he will start looking for work. However, Nancy will then start a three-year MA course. They have £170,000 in a post office account, awaiting reinvestment. They also expect to receive a further £30,000 in five months' time. This aside, they have £4,000 in a building society and Nancy has an ISA with Perpetual.

Once Nancy has finished her course they will think about using their money to buy a house. In the meantime, they want to get as good a return as possible from their money but are quite averse to high-risk investments.

The adviser: Tim Cockerill, managing director at Whitechurch Securities, independent financial advisers in Bristol (0117 9442266)

The advice: Bearing in mind Nancy and Mark's intention to buy a home, it is important to safeguard the bulk of their capital. The first thing to ascertain is how much money they should keep in the building society. Nancy's course fees are likely to be about £20,000 and their car has seen better days. Therefore a further £10,000 should be set aside for this.

They are cautious in their approach to investment and I would therefore suggest a further £50,000, making a total of £80,000, to be held in the building society.

They should take into account the fact that Mark may not find a job immediately after finishing his course. As either one of them may be a non-tax payer, due to their student status, the account is best paid gross, enabling them to make the most of their tax allowances. The bulk of the money should be held in what I would term the middle ground and this can be defined as low to medium risk.

First, I think they should have a look at the income bonds currently available from Scottish Mutual and AIG (American Insurance Group). Both pay 8 per cent net and guarantee the return of their capital but there are certain provisions. The Scottish Mutual bond has a three-year term, AIG has a four-year term.

The return of the original investment is linked to a stock market index, in the case of AIG it's the FTSE 100. If in four years' time the Footsie is either at the same level or higher than at the beginning of the term, the original investment will be paid back

If the market falls over that period then there is a one-for-one capital loss. So, if the market were down 2 per cent the capital will lose 2 per cent of its value. The chances of this happening are very low and, in exchange for this risk, Nancy and Mark will benefit from an 8 per cent net income.

The Scottish Mutual bond is similar, although it is based on a European index and only has a three-year term. Its added attraction is that the index can fall by up to 20 per cent and yet the original capital is returned.

Next, I think the Campbells should look at zero-dividend preference shares. They work by generating a set annual return to the end of the life of the trust. I would suggest Guinness Flight Extra Income which has 3.2 years to run.

Over this period one could expect annual returns of 7 per cent. The gain comes in the way of capital appreciation and is only subject to capital gains tax which will not be an issue for either Nancy or Mark.

A big benefit of zeros is that the risk can be quantified through what is known as the "hurdle rate". In the case of the Guinness Flight trust it is minus 16 per cent, which means that for the next 3.2 years the value of the trust can go down by 16 per cent a year but investors will still receive their capital back, plus 7 per cent per annum. Although complex, and this is one of the reasons why they are so overlooked, zero-dividend preference shares are excellent investments.

Finally, for the middle-ground section, I am tempted to propose a with- profits bond. This is slightly controversial because they are considered to be longer-term investments spanning five years at least.

Indeed, they have exit penalties if cashed in early. The exit penalty actually reduces as time goes on but if they were encashed after three or four years it would still apply.

So why am I looking at them? First, because they are extremely secure investments which guarantee your capital value. It is also a comfort that a bonus, once added on, cannot be taken away. There are exceptional circumstances in which a "market value adjuster" (MVA) would be applied which could, potentially, reduce the value of your investment upon withdrawal. However, Scottish Widows has never applied it.

This bond presently pays 5 per cent net per annum and Nancy and Mark would benefit from the terminal bonus when they encash the bond.

At present, Scottish Widows bonds are returning in the region of 10 per cent-plus after three years. The exit penalty will, of course, put a small dent in the return but an advisor can easily compensate for this by enhancing their initial allocation by rebating a part of the commission.

I would suggest a split between these recommendations along the following lines: Scottish Mutual Income Bond £15,000; AIG Income Bond £15,000; Guinness Flight £25,000, Scottish Widows £45,000; making a grand total of £100,000.

The remaining £20,000 I would suggest be placed into equity investments. To this end I would suggest that Mark place £ 7,000 into an ISA, such as the one run by Fidelity, and I would recommend using its UK Growth and Special Situations trust to give a good mix of UK investments. I would split the remaining £13,000 putting £ 6,500 into Jupiter UK Growth and £6,500 into HSBC UK Growth and Income.

Nancy and Mark would need to take a five year view with this investment. But since it only represents a small part of their overall assets it should not affect their house purchase.