Investing in the Stock Market: Put your eggs in a variety of baskets

Unit trusts and Oeics provide an easy way to invest in diversified portfolios, writes Tony Lyons

The 15 million or so private shareholders in the UK have mostly obtained their shares from the spate of privatisations and demutualisations. This means that most only have shares in one or two companies.

This is not the best way to invest. When it comes to stocks and shares you need a well-diversified portfolio to hedge against disaster.

Share prices can be very volatile over the short term. Over the long term - five years or more - they have almost always outperformed any other home for your savings. Finding the right companies to buy into involves a great deal of research. Most of us lack the time or expertise to do this properly.

But don't worry. Unit trusts and new European-style open-ended investment companies (oeics) offer a ready-made solution: a share in ready-made, diversified portfolios.

According to the Association of Unit Trusts and Investment Funds (Autif), there are almost 13 million of these accounts, including people investing through PEPs and ISAs.

They may lack the excitement of directly investing in equities but are simple to understand and easy to buy and sell.

Unit trusts and oeics are open ended, which means they can just create extra units for new buyers. The value of each unit is equal to the value of the fund divided by the number of units in existence.

While unit trusts are set up under trust law, with a trustee looking after the unit-holders' interest, oeics are governed by company law. For ordinary investors, the most important difference is in their pricing. Recently, unit trusts were allowed to introduce single pricing, but almost all still work on the old system of having an offer and a bid price. The first is the cost of buying, and includes any initial charge, while the latter is the price you get if you sell.

Oeics were introduced to enable British fund management groups to compete more effectively for business in mainland Europe. They have just one price, which is the same for buying and selling. Charges are shown separately on statements sent to the investor.

Oeics have been set up to be umbrella funds. This means that you have a choice of sub-funds to invest in, although cash funds or "funds of funds" are not allowed and remain as unit trusts. Switching between sub-funds is easy and usually free.

With most unit trusts switching within the same management group is just as easy. Managers such as Schroders, Jupiter, M&G and Perpetual allow this either free or at a heavily discounted cost, usually around 0.5 per cent.

Some large groups, such as Fidelity and Threadneedle have adopted the oeic wholeheartedly. Others, including some of the largest, have still to do so.

Bridget Cleverly of Schroders admits: "Our current systems cannot cope with the changeover. However, we will probably convert our funds to oeics within the next two years."

Others point out that there can be pitfalls with the oeic structure. "All equities have a buying and selling price, so it's relatively easy to work out the mid price," says Stephen Glynn of Jupiter. "However, if the stock market moves by more than 2 per cent or someone wants to invest over pounds 15,000, then the fund manager has the right to impose a dilution price, which will probably be lower than the mid price, to protect existing holders."

With nearly 1,800 funds to choose from, where do you start to find a good investment? First, work out your goals and time horizon. Decide if it is income or growth you are after.

"The longer your time frame, the more likely the investor should aim for maximum growth," according to Jeffrey Mushens of M&G.

Then look at the risks you are prepared to take. Do you want to speculate in small companies or emerging markets? Or will you be happier in a fund that invests in British blue-chip companies and less likely to suffer violent fluctuations in price ?

"It makes sense for the first-time investor to stick to the UK," says Ann Davis of Fidelity. "When you are used to investing, then venture overseas."

Mr Glynn agrees: "Keeping a reasonable amount of your investment at home, you will avoid the currency risks that go with overseas investment. Start with UK investment and then, when experienced, still have up to 70 per cent of your money in the home market. Clearly there's money to be made overseas, but there are risks.

"You would be feeling very happy if you bought into the Far East at the start of this year, but if you bought in early 1998, you'd be feeling a bit sick after the collapse of emerging markets last summer."

You should also look at the charges. Tracker funds, especially those investing in the widely-based FT All-Share, usually outperform active funds and have much lower costs.

If you want an actively managed fund, in the hope of beating the index, then you can save cash by buying through a discount broker.