TAX PLANNING AND SAVING: Start a PEP and add a little spice

Stake your money on the stock market and you could be in for a roller-coaster ride. In the short term, investing in company shares is a stressful game best left to people with a lot of money to lose. But if you are in for a long haul, an investment in shares through a tax-free personal equity plan can be the answer.

In the past a long-term investment in equities always did much better than money left on deposit at a building society. Building societies pay out less because your money faces little risk. Company shares can lose value rapidly and whole markets can crash. But those short-term rises and falls are generally smoothed out over time.

If you already have a rainy- day fund tucked away somewhere safe and accessible, it could be time to think about building up a PEP.

Every adult is allowed to invest up to pounds 9,000 each tax year in a PEP. Up to pounds 6,000 can be put into a "general" PEP and the remaining pounds 3,000 can be invested into a "single company" PEP, which invests in the shares of just one company as opposed to a spread of companies.

The structure is flexible. All PEPs have to be organised by a plan manager approved by the Inland Revenue. With some PEPs the manager will make all the investment decisions; with others you instruct the manager about which shares to buy and sell. The strategy will probably depend on how high you rate your investment skills and how much time you have. Most people pick a PEP that lets the manager call the shots.

Nowadays there is a wide variety of PEPs. With the most common type of plan the manager will put your money into one or more unit trusts. These are collective vehicles that pool investors' money to buy shares. Various unit trusts are managed to achieve different aims: for example, good capital growth, high income, a focus on small firms, or a stake in all the FT-SE 100 companies.

Most PEP managers will place your money in a few types of funds. Some PEPs, however, do not invest in equities at all. The Corporate Bond PEPs invest in debt certificates and preference shares issued by companies. These are generally aimed at investors who want to generate income, not build up capital.

There are also Guaranteed PEPs that offer the combination of full-growth potential and the guarantee that your capital is secure if you hold on to the PEP for an agreed length of time, such as five years. With a big manager it is also possible to make your own hybrid PEP, combining equity growth, income and bonds. You do not need a lot of money to get started. Some PEPs require a minimum lump sum investment but many allow you to stash away a small amount each month.

When you come to choosing your PEP, it is important to have a clear understanding of how much you are going to be charged by the plan manager. Investors will normally have to pay an initial charge when they put money into a PEP, paying it monthly or in a lump sum. The amount varies with the companies. "Anything in excess of 5 per cent should be resisted," says Stewart Aylward, financial planning manager with Grant Thornton, a firm of accountants.

There will also be an annual management charge to pay. The size of this will vary according to the type of fund. If the fund manager is just tracking an index such as the FT-SE 100 the charge should be about 0.5 per cent because the fund manager does not really have to do anything.

"If you are going for a fringe- type investment where more research has to be done, such as with smaller companies, the annual management charge will be higher," says Mr Aylward. "But once the annual management charge goes over 1.5 per cent per annum, I would say that is somewhat excessive, though it has to be put into the context of the performance the fund manager delivers."

But it is a general rule that you should not necessarily go for the plan offering the lowest charges because the important thing is fund performance.