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By Sarah Modlock

Ouch. Some saw it coming, many didn't. But the turbulence which hit world stockmarkets this summer caused many stomachs - and portfolios - to lurch. At the end of July, the FTSE 100 declined more than 400 points in a week, or 6.3%, its largest weekly drop in more than three years. Even if you don't hold shares directly, you pension will be affected as funds gain much of their growth over the long term my investing in stocks and shares. Given time, things should even out and this should not be a big problem unless you are due to retire very soon.

Since March 2003, the FTSE 100 has increased from less than 3,300 to around 6,200. If you've owned equities during this time, you probably feel pretty pleased about your investments. But financial advisers Edward Jones say that market declines are more common than we might think, highlighting February this year when the FTSE 100 fell more than 400 points. It also dropped 600 points in May and June 2006. In fact, declines of 10% happen about once every three years in the UK and about once a year in the US. However, don't let some short-term forecasts scare you into changing your long-term plans. Stay focused on the things you can control, such as the quality of the investments you own, the diversification of your portfolio.

Situations like this often polarise investors. Some are keen to play things safe, taking their money into bonds or savings accounts. For many, it is the perfect opportunity to buy shares while they are cheaper, or invest in a FTSE tracker, the idea being that they will profit as and when the market rises.

The fun starts when you try to pick the right product. The tables below, from independent listing website Moneyfacts, may give you some food for thought.

Top 10 UK trackers over 3 years
£1000 invested, offer/bid, net income reinvested at pay date.

Source: Moneyfacts.co.uk, Prices as at 22 August 2007, Fund Performance figures supplied by: LIPPER LTD


Top 10 UK trackers over 5 years
£1000 invested, offer/bid, net income reinvested at pay date.

Is the name bond?
According to Anja Eijking of F&C Management, convertible bonds have been one of the best kept secrets of the investment world in recent years. However, with rising interest rates, low returns on conventional corporate bonds and concerns about a potential correction in equity markets, Eijking, who manages the F&C Global Convertible Bond Fund, believes that convertibles can offer investors an attractive half-way house between bonds and equities.

"10-year UK bond yields have increased from 4.9% at the end of March to around 5.5% today. At the same time equity markets have come under increasing pressure from the slowdown in US growth. However, although we agree there is some uncertainty in markets over the short term, we remain positive about the longer term outlook for financial assets, not least convertibles. The short duration of convertibles limits the potential impact of rising bond yields and rising equity market volatility should also prove beneficial," said Eijking.

"The truth is that no one can predict what will happen in six months time. Convertible bonds offer investors peace of mind by giving them security of income through regular bond coupons whilst at the same time offering exposure to equity market returns with the option to convert the bonds to shares on maturity. They will also pay the fixed face value of the bond at the redemption date regardless of any fall in the equity option. Convertibles have not been widely understood by private investors, many of whom rarely venture beyond the traditional asset classes of bonds and equities. Yet historically the long term risk/reward profile of convertibles has been superior. Indeed on an annualised basis, convertibles have outperformed both equities and bonds over the last 10 years and their low correlation to both the equity and bond markets make them an attractive addition to any portfolio," concluded Eijking.

It's true that bonds are seen as generally less risky than having a share in a company. But one of the main risks they do have is that the company you have lent money to can't pay the interest due or cannot pay the money back at the end of the term (for example, if it has gone bust). It is generally considered that these risks do not apply to gilts (loans to a government). With lower risk, you can usually expect lower returns.

Be prepared for the next market move
Edward Jones say that the best defense against a stock market decline is to own quality investments and to diversify your portfolio properly:

• Review your asset allocation - Share returns have been in double digits for the past four years (2003-2006). As a result, many investors may have too little fixed income in their portfolio. Rebalancing to the appropriate mix of equities and fixed income is a good idea at this time.


• Ensure your equities are diversified - The large gains in materials and energy shares may mean they have taken up too much of your portfolio, so rebalancing may be appropriate. If you mainly own mutual funds (unit trusts), your portfolio managers will generally keep your funds diversified, but if you primarily own individual shares, consider reviewing your portfolio to reduce overweight areas.


• Reduce aggressive investments - Over the past few years, aggressive investments, such as emerging markets and high-yield bonds, have performed well. They tend to perform better when markets are rising, but they also tend to drop more when shares decline. When markets become more volatile, it's a good time to consider reducing the risk in your portfolio.
  
• Ladder your fixed-income investments - Owning fixed-income investments that mature over a series of years from a variety of different issuers can provide steady income that balances your portfolio.


• Invest internationally - Domestic equities have outperformed many foreign investments, and the strong pound makes foreign investments attractive. Edward Jones recommend placing 15% to 35% of your portfolio outside the UK to improve your diversification.