It's a question of balance

If buying shares gives you the jitters, why not calm your nerves by trying out with-profits bonds

Balancing risk with return is a problem that soon becomes familiar to investors. Some of us are happy to buy stock market shares, knowing that greater returns are possible than had we stuck to the bank or building society, but that we might be in for a volatile ride. Others would rather opt for peace of mind than potentially higher gains; those, for instance, nearing retirement with little time to make good losses in investments, need more stability.

Balancing risk with return is a problem that soon becomes familiar to investors. Some of us are happy to buy stock market shares, knowing that greater returns are possible than had we stuck to the bank or building society, but that we might be in for a volatile ride. Others would rather opt for peace of mind than potentially higher gains; those, for instance, nearing retirement with little time to make good losses in investments, need more stability.

The trouble is that the greatest stability comes via savings accounts, most of which offer unspectacular returns. Even if you hunt down one of the better deals - Nationwide's e-Savings pays 7 per cent interest - returns aren't anywhere near as high as those you can make on the stock market.

But there are investments available which limit risk while offering higher returns. With-profits bonds are the most popular choice, with investors put- ting £12bn into them last year. and interest showing no signs of waning.

If you have a lump sum to invest (most bonds require a minimum of £5,000) and are looking for low to medium risk over the medium to long term, worth investigating is the with-profits bond offered by insurers. Risk is limited because the insurance firms invest in a mix of shares, property and corporate bonds. This type of investment smoothes out the bumps of the stock market by holding back some profits when the markets are doing well and giving them out when the markets are not doing so well.

"They are a useful second tier up from saving in building society accounts and give a nice even growth," says Kay Lowe at independent financial adviser (IFA) Equal Partners.

As well as an interim bonus, payable annually, quarterly or monthly, with-profits bonds also pay a terminal bonus when cashed in - which, as they are open-ended, can be done at any time. When choosing a with-profits bond it is important to take into account more than just past performance. "A lot of investors will just go on the bonus rate, which is not the right thing to do," says Martyn Laverick, director at the IFA, Chartwell Investment Management. "They could have a very attractive bonus rate in the first year which then drops off in subsequent years."

Instead, it is important to look at the financial strength of the insurer offering the with-profits bond to ensure they have enough in reserve for bonuses; if so, they are likely to invest more in equities, leading to higher returns for investors.

The new with-profits bond from Standard Life should be reliable. The company is "triple A" rated and has got the money to invest heavily in equities; it should mean there is, in the longer term, greater potential for higher returns. Even though this product, being new, has no track record, investors can be reassured the company is solid. Standard Life has set the interim bonus at 4.5 per cent a year initially. A terminal bonus may be added on cashing in or at the time of withdrawals.

Investors may not be that impressed with 4.5 per cent, but Mr Laverick believes the figure should be sustainable. Typically, interim bonus rates range from 5.25 per cent to 6 per cent.

Although with-profits bonds are criticised for theircharges - higher than many unit trusts - some insurers offer extra units when you start the investment. For instance, for every £1,000 that investors put into a Standard Life with-profits bond, units with a face value of £1,020 are credited to it.

Most with-profits bonds have initial charges of about 5 per cent, along with annual management fees of about 1 per cent. But discount and specialist brokers should offer a hefty discount on the initial charge.

"They are not a sophist- icated or precise way of transferring risk - they provide no real certainty, no clarity," says Neil Lovatt at Scottish Life International. "They are presented as a safe fund but they can fall in value because the terminal bonus is not guaranteed. There are much better risk-management alternatives."

* Chartwell Direct offers readers a with-profits bond guide at www.chartwelldirect.co.uk. Tel: 01225 321710