Investing in a falling market


The fall in the Footsie this week comes at a bad time for those investors who haven't yet used their Isa allowance but are considering buying into equities.

Share prices on screen

Although there is the argument that fresh investors are getting a better deal as shares are cheaper as a result of the falls, the rapid drop in the market will have done little for investor confidence.

According to the financial experts, the drop, which wiped out all of the FTSE 100's gains this year, was a healthy correction and the four-year bull-run is likely to continue.

But the truth is that no-one can truly predict what will happen in the future. For those investors that want to use their Isa allowance but are unsure what to do with it, we outline some options to consider. Savers can either put £7,000 into a maxi Isa, or split their £7,000 allowance by putting £4,000 in equities and £3,000 in cash.

Keep it in cash

Mark Dampier, investment expert at Hargreaves Lansdown, says: 'If you are that nervous about the market at the moment, keep your money in cash and invest when you think they markets offer better value.' You can actually 'reserve' your Isa allowance for this year by keeping it in a cash account and then invest the money when you feel more comfortable about the state of the market.

Investors in Hargreaves Lansdown Vantage Isa, for example, can hold their £7,000 Isa allowance in cash this tax year and wait until after April 6 – the new tax year - to invest it. Their £7,000 allowance for the new tax year remains unaffected, so in effect the investor can invest £14,000 tax-free in the one tax year.

The cash earns 4.5% interest while it is being held, but it doesn't enjoy tax-free status until it is actually invested, so the interest is taxed.

Alternatively, just use the cash part of your Isa and ignore equities altogether. According to Capita Registrars, investors have been taking money out of shares and keeping the money in cash because the recent increases in the bank rate have made cash accounts more attractive. Newcastle Building Society is currently offering 6.1% on its cash Isa, while NS&I is paying 5.8%.

Phase your investment

It is possible to hand over your full £7,000 Maxi allowance now to a fund supermarket and then phase the investment into your required funds over the following months. This has the benefit of 'pound cost averaging', which is useful in a volatile market. For example, when a unit trust price has fallen, then more units can be purchased for that month. Similarly when the price rises then fewer units can be purchased.

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Financial graph with magnifying glass

Over a period of a few months, the average price paid will be lower than the average unit price for that period as more units are bought at the lower price and fewer at the higher price.

You can phase your investment over three, six, nine or 12 months, although you should check with your Isa provider on any restrictions, and interest is earned on the proportion that is still held in cash. Fundsnetwork, which powers This is Money's fund supermarket partner Skipton Financial Services, allows investors to phase their Maxi-Isa over six months and pays the Barclays basic savings rate in interest.

Capital protected products

These plans offer a chance to share in any stock market growth over a set period, but promise the capital back at the end if markets have fallen. They suit lump sum investors, not regular savers, and can be held within an equity Isa.

If the market does rise over the term, you will not do as well as if you invested directly in the index through a tracker fund because you do not get any dividends - income paid out by companies to their shareholders. The difference is basically the insurance you pay for the guarantee that your investment will not fall.

Justin Modray, head of communications at financial advisor BestInvest, likes the Morgan Stanley FTSE Protected Growth Plan 16. It offers 150% of FTSE 100 growth over a six-year term. However, if the Index has risen by 30% or more by the end of the third year, the plan closes and the investor receives their initial investment plus 30%.

Defence and income orientated funds

Defensive stocks are those that tend to perform well regardless of market conditions, such as utilities, food producer or tobacco companies. They tend not to produce spectacular capital growth, but offer investors income and less volatility than a fund that chases growth. Funds in the Investment Management Association's Equity Income sector tend to invest in defensive stocks.

One name mentioned by most financial advisors when looking for a safe pair of hands is Neil Woodford, who runs the massive Invesco Perpetual Income and High Income funds. Darius McDermott, managing director of Chelsea Financial Services, says: 'He has been defensive for the past two years and been wrong but has still finished on top because he is such a skilled stock picker. People wonder whether managing such large funds can be a hindrance, but he's managing remarkably well.'

McDermott also likes Rensburg UK Select, which is actually a growth fund. He says: 'The manager Mark Hall always watches for the downside and his fund tends to be less volatile than others.'

Finally, he recommends the Schroder Income Maximiser fund which aims to provide a high and sustainable level of income by using a 'covered call' strategy. A covered call is a form of derivative that is essentially a bet on the future direction of a share. 'By using covered calls, the fund can outperform in downwards or sideways markets.' More information can be found on covered call funds here.



Share price graph in newspaper

Multi-asset or cautious managed funds

These funds invest across a broad range of assets, including equities, bonds, property, commodities and cash, both domestically and internationally. They are heavily invested in fixed income style investments and the holding in equities can be as little as 30%, so while they don't offer exciting capital growth, they lack volatility and are a great portfolio stabiliser.

Justin Modray IFA

Justin Modray is a big fan of the Midas Balanced Income fund, which holds 40% in UK and global equities and the remainder in property and fixed interest investments. He adds that investors should also take a look at the new Fidelity Multi-Asset Strategic Fund and the Scottish Widows Investment Partnership's new Diversified Assets fund.

Meanwhile, Jason Walker, senior manager with AWD Chase de Vere, likes the Investec Cautious Managed, Schroders Cautious Managed and Gartmore Cautious Managed fund.

Fund of funds

As the name suggests, these are funds that invest purely in a range of other funds. Also known as multi-manager funds, the benefit to the investor is that they get a diversified portfolio of investments under one holding without having the hassle of having to research the individuals funds themselves. They can specialise in a particular sector or geographical location.

These funds often have two layers of charges – one to cover the managers managing money within the portfolio, the other to pay for the overall manager who hand-picks the managers in the first place. Investors should also check whether the fund manager is limited to buying into funds offered by his or her own investment house or whether they can buy from the wider market as this can hinder performance.

Jason Walker likes the Jupiter Merlin range of fund of funds, overseen by John Chatfield-Roberts, and was also a fan of the Credit Suisse range of multi-manager funds, but managers Gary Potter and Robert Burdett left earlier this week.

Investing in a falling market

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