When the economic situation is as unpredictable as it is now, it is a sensible precaution to spread your investments widely. Alok Dhanda gives some advice on how to do it.

WE’VE all heard the saying, “Don’t put all your eggs in one basket” and this is especially true when it comes to our personal finances.

If your money is sitting in a bank or building society savings account, then this shows that you have good intentions to grow your money, but be warned – this isn’t always the most rewarding option, especially in the current marketplace.

The rate of Consumers Prices Index (CPI) inflation rose to 4.5% this month, with the increased cost of clothing, petrol and heating all acting as contributing factors. Combine this with the low 0.5% interest rate, and this makes for a very sour outlook for our finances.

Our savings are losing their purchasing power and they look set to be eroded further by the rate of inflation over the next couple of years. This calls for a savvy approach to our money, to ensure it works harder in these tough economic times. One solution worth considering is diversifying your portfolio. Spreading investments across a range of assets is one of the best ways to balance risk and reap higher returns.

There are four main asset classes – cash, bonds, property and equities, all with different risk characteristics and behaviours. Some assets are known as negatively-correlated assets, such as bonds and property, which behave in a different way by offering lower but less volatile returns. A perfectly negative correlation occurs when one of these assets goes up and the other goes down.

Stock markets have remained choppy in recent weeks, with many investors awash with anxiety. As prices take a tumble, this is a great opportunity to buy shares, which are now considerably cheaper than they were just a matter of weeks ago. It’s worth remembering that although the markets are volatile now, they will go up again in the future, as they did following the downturn in 2008.

As well as investing across a range of assets, it’s also worth considering the geographical spread of your money. Markets in Europe and further afield in Japan and Asia may appeal to the more daring investor seeking lucrative returns. Drip-feeding money into emerging markets such as India, Brazil and Russia every month is a strategy many investors employ so that when the market improves, their investment also goes up.

Structured products that don’t put your original investment at risk are increasing in popularity, too. These products have a fixed maturity, with your money being tied up for five to six years, for example. Usually, they are linked to indexes like the FTSE 100 or the price of an asset such as oil or gold. If this goes up, your investment increases. The question is: do you want your money to be tied up for this period of time, with no guarantee of capital growth?

Further investment options include unit trusts, OEICs (open-ended investment companies) and investment trusts. These pool investors’ money together in a large shared fund with a professional fund manager, with the aim of delivering the highest returns. This allows you to invest across different funds and in different sectors without having to spend time managing the investments yourself.

For those who prefer a less risky approach, there are various alternatives to the traditional high-street savings account. Take a look at Friendly Society Tax Exempt Savings Plans, where you can save a maximum of £25 per month or £270 per year, and plans must run for a minimum of 10 years.

Another savings option to bear in mind is with-profits funds, which are a type of investment with a life assurance provider. The money you put in is pooled with other investors’ money and invested in a mixture of shares, bonds, property and cash. If the investment performs well, you should get an annual bonus each year, as well as a terminal bonus when your policy comes to an end.

It’s important to consult an independent financial adviser (IFA) as investment products can be very complex. An IFA can offer impartial advice and guidance on the various options available by assessing how much can you afford to invest and how long you would like to invest for.

:: Alok Dhanda runs Dhanda Financial, 52 Dean Street, Newcastle, NE1 1PG, telephone 0191 255 8960, email alok@dhandafinancial.com  or visit www.dhandafinancial.com