WITH less than a month to go before the end of the tax year, fund managers are bracing themselves for one of the worst Isa seasons for years.

The FTSE 100 index of leading shares has dropped 12% since January 1 and, with analysts warning that the turbulence could be far from over, investors are understandably concerned about committing cash to the equity markets.

Investors pulled £70m out of stocks and shares Isas in January alone, according to the Investment Management Association.

However, advisers said that the long-term benefits of investing through Isas remain compelling. For example, if you invested £7,000 in equities every year from 1999, when Isas were launched, to 2019, you would end up with a pot worth £280,000 inside an Isa but only £264,000 outside after higher-rate income tax, the Investment Management Association said. And that is before you take into account capital-gains tax of £36,000 when you sell outside an Isa.

Some experts are even saying this could be one of the best times in years to invest in an Isa. Richard Buxton of Schroders, the fund manager, said: “There is an awful lot of bad news in share prices and if you’re investing with a two- or three-year time horizon, it could actually be the perfect time to invest.”

If you’re still nervous, several investment firms and fund supermarkets, including Fidelity, offer a phasing option, where your money is gradually invested over a number of months – but will still count towards your 2007-8 allowance (see below).

However, you need to get you skates on – those who have failed to use their Isa allowance by April 5 will lose it forever.

This year, you can invest up to £7,000 in an equity Isa, free of income and capital gains tax. Alternatively, you can split this allowance, investing up to £3,000 in a risk-free cash Isa, and up to £4,000 in a stocks and shares Isa.

From April 6, you will be able to invest up to £7,200 in an Isa. Again, you can split the investment, so that a maximum of £3,600 is held in a cash Isa, while the remaining £3,600 of your allowance can be invested in a stocks and shares Isa.

Another change in April is that investors in cash Isas will be able to move into equity Isas, but not vice versa. Any transfer you make will not affect your allowance for that tax year.

This means that if you are particularly nervous, so as not to waste your full allowance this year, you could invest in a cash Isa as a short-term safe haven then move into equities when you feel more confident.

Here is our guide to making the most of your Isa allowance in volatile times.

Make sure you have a balanced portfolio

Many investors feel safest sticking with what they know, but having a portfolio that concentrates on one particular investment area is a risky strategy.

The rule is simple – spreading your portfolio over several different investments helps limit any losses should markets fall. Conversely, when markets rise, you will be able to take advantage of all the best-performing sectors.

Make sure your investments are appropriate for your risk profile (see pie charts) and always seek professional, independent financial advice.

Cautious investors who want to minimise risk should hold about 40% in fixed interest securities such as corporate bonds and gilts, according to Philippa Gee at financial adviser Torquil Clark.

Corporate bonds are in effect loans to companies which pay a fixed income to investors – equivalent to the interest on a loan. Gilts work the same way but you are lending to the government. As well as bond funds, Gee suggests that a cautious portfolio should hold 15% in property, 22.5% in UK equities, 17.5% in global equities and 5% in riskier emerging markets.

If you’re prepared to accept a moderate level of risk, Philip Pearson, of Southampton-based advisers P&P Invest, suggests investors should hold around 27% in fixed-interest funds; 24% in property; 25% in UK equities; 5% in European equities, and 16% and 3% in US and Far East equities respectively.

For adventurous investors, Martin Bamford of Informed Choice, another adviser, suggests about 55% of a portfolio should be invested in UK equities, with the remaining 45% in overseas equities, including 15% in Far East equities and 15% in emerging-markets equities.

If you haven’t got a balanced portfolio, look at a multi-asset fund

As their name suggests, multi-asset funds can be a useful diversification tool, as they invest in a wide choice of assets. This means that if one asset performs badly, investors will have exposure to other assets at the same time which may not be affected by any downturn.

For example, Fidelity’s Multi-Asset Strategic fund invests across five asset classes – equities, bonds, cash, property shares, and commodities, and asset allocation is changed regularly to give competitive returns as the economic cycle shifts. Other multi-asset funds include the CF Ruffer Total Return fund, which has risen 9% since January last year and invests in equities, bonds and currencies.

Andrew Wilson, head of investments at Towry Law, an adviser, said; “Investors should ensure they hold the right blend of noncorrelated assets – those which will not fall and rise together – and with this should be in a better position to ensure more consistent returns and fewer sleepless nights.”

If you have a balanced portfolio but you’re still cautious, consider bonds

Now could be a good time to beef up the bond part of your portfolio. They have delivered poor returns in recent years, but performance is picking up as the global economy has faltered and interest rates around the world have been cut. Bonds pay a fixed income and therefore become more attractive when interest rates are falling.

Gee likes bond funds such as Artemis Strategic Bond, and F&C Strategic Bond, both of which invest in a mix of higher-risk and high-quality bonds.

Bamford tips Invesco Perpetual Corporate Bond, which has slipped 0.95% in the past 12 months, against a fall of 3.61% for the average bond fund.

If you are cautious but want an equity fund, he recommends the Blackrock Merrill Lynch UK Dynamic Fund, which has returned 5.69% in the past year, compared with a fall of 5.44% for the average fund in its sector.

If you’re feeling brave, how about America?

If you already have a balanced portfolio that you want to top up this year, and you’re feeling brave, Pearson’s UK tip would be M&G’s Recovery fund, which invests in companies the manager believes are undervalued.

Emerging markets are also tipped for long-term investors. Bamford recommended the JPM Emerging Market Equities fund, while Gee tipped AXA Framling-ton’s Emerging Markets fund.

Remember the benefits of regular saving

Drip-feeding your money into the stock market can be a good way to help smooth out the effects of market volatility. Regular saving not only avoids the risk of bad timing – putting a lump sum in just before prices fall – but it also removes the stress of trying to second-guess the stock market’s next move.

If you’ve left it late, how about phasing?

If you’ve left taking out an Isa too late, however, investing monthly is not an option because you will not have time to use up this year’s allowance. This is where phasing comes in.

Several investment firms and fund supermarkets, including Fidelity, offer a phasing option, where your money is gradually invested over a number of months. If the stock market drops, you can then buy more shares at lower prices.

Say you want to invest your full Isa allowance of £7,000 in an equity fund before the end of the tax year, but do not want all the money to go into the market straightaway. Your lump sum might be split into six equal amounts. The first £1,166.67 would be invested immediately and the rest in five equal amounts over the next five months.

As long as you buy the phased investment before April 5, it will still count towards this year’s Isa allowance.

Fidelity has also launched the Cash Park Isa for cautious savers. This allows you to secure your full £7,000 allowance without immediately committing the money. As long as you intend to invest the money at some point, the Revenue is happy for you to keep the money in cash.

The Cash Park fund pays a gross rate of 4.85%, although the Revenue insists that cash held in investment Isas is taxed at 20%, so interest is paid net.

Don’t fall for the protected trap

Isas that claim to enable investors to benefit from stock-market growth, while promising to return capital in full even if markets plummet, sound like the perfect investment – but make sure you read the small print.

Capital-protected Isas promise to give back your full capital investment after a given term – usually five or six years – plus a return based on the performance of a stock-market index, such as the FTSE All-Share or FTSE 100.

But unlike tracker funds, which follow a stock-market index, you don’t benefit from dividends. You also won’t be able to take out your money during the investment period without forfeiting the capital protection and face the possibility of getting back less than you invested.

Julia Whittle of Punter South-all, an adviser, said: “Capital-protected products are often expensive and inflexible. There are a lot on the market now as they are slightly cheaper to manufacture as markets are relatively low.

When you ideally want them is when markets are high — and you want to protect capital — then, of course, they are very expensive. When markets are low your capital is arguably likely to recover over time and so you are less likely to need capital protection

SAVINGS FOR GOOD AND BAD TIMES

PETER Maxwell, 35, is making regular savings into Fidelity’s Multi-Asset Strategic fund to help minimise the impact of stock market volatility.

Maxwell, an educational psychologist, lives with his wife Ruth, 35 and their three children, Jack, eight, Lucy, two, and Ben, eight weeks, in Armagh, Northern Ireland.

He said: “I made a lump-sum investment of £3,000 into the Multi-Asset fund at the beginning of the tax year, and since then have been paying in £50 a month.

‘I chose this fund because of the diversity it offers – as it invests in a range of assets which means it should hopefully do well in both the good times and the leaner times.’

The Fidelity fund offers exposure to equities, bonds, cash, property and commodities and has an initial charge of 3.5% and a 1.25% annual charge.

HOW THE RULES WORK

- This year, you can invest up to £7,000 in a stocks and shares Isa, free of both income and capital gains tax.

- Alternatively, you can invest up to £3,000 in a risk-free cash Isa, and up to £4,000 in a stocks and shares Isa.

- From April 6, you can invest up to £7,200 in an Isa – or £3,600 in cash and £3,600 in shares.

- You will also be able to move money into equity Isas from cash schemes, but not vice versa.

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