How do you magnify the value of your stock market investment by up to 30 times and pay little or no tax into the bargain? The answer for increasing numbers of investors is to use contracts for difference (CFDs) and spread-bets.

These financial instruments allow investors to gear up their cash by effectively betting on shares while avoiding stamp duty and, in some cases, capital gains tax too. So popular has this combination proved with investors that several brokers are now offering an advisory service covering CFDs. For those with wealth measured in at least five figures, Hoodless Brennan, City Index Advisory and IG Index will provide recommendations, or even manage a portfolio, of CFDs on your behalf.

Given the risks involved, you might think such advice was essential. CFDs work on the basis that, instead of paying the full cost of a share, investors benefit, or lose, from the difference between the price of a share when they open a “contract” and its price when they decide to close the contract at a future date. So, if you think that a particular share will rise, you buy a CFD. If on the other hand, you are expecting a fall, you sell.

Spread-bets work in a similar way, with the punter betting, for instance, £10 for every penny or point rise or fall in a share or index. The crucial difference is that gains from spread-betting are free of capital gains tax.

The risk comes from the gearing effect. For both CFDs and spread-bets, your broker asks you to put up a margin of, say, 10 per cent of the value of the underlying stock. If the underlying share price rises by 10 per cent, you double your money; but if it falls by that, you are wiped out. You must either bite the bullet and close out the bet, or contract, or put up more margin to stay in the game.

Mark Rayden, product development manager at Hoodless Brennan, the stockbroker, says: “It can be quite expensive if you don’t watch what you are doing. If you get it wrong, you are magnifying the loss and the charges.”

Charges for trading CFDs are superficially attractive. Fees for execution only at Hoodless Brennan and IG Index are 0.1 per cent of the underlying share. This is cheap compared with buying shares through a broker, where you would also have to carry the cost of the 0.5 per cent stamp duty.

But, if you go “long” with a CFD – bet that the price will rise – you also have to meet financing charges, typically set at an annual equivalent rate of the base rate plus 2.5 per cent. If you go short, you may receive interest, usually at 2.5 percentage points below the base rate.

Any remaining cost advantage for CFDs is narrowed further with the advisory services. Hoodless Brennan, for instance, charges 0.5 per cent per transaction for advice. Clients at City Index Advisory, the spread-betting firm, pay a 0.25 per cent transaction charge to gain access to Apollo, the “black box” at the heart of its service. Developed with Icapan, an interdealer broker, Apollo is an automated research tool that is meant to signal when shares and indices are over or undervalued. Clients must demonstrate the trading experience and wealth to handle the risks.

If this sounds too racy, there are lower-risk ways of playing with CFDs. Investors with a minimum of £20,000 can have a portfolio of about ten positions managed by IG Index, through its Enhanced Growth service. The portfolio can go short, but the investor is guaranteed not to lose more than he has invested.

Warren Firth, the manager, says: “What we have done is bring the hedge fund model down to individual investors.”

Over its first three years to the end of May, a model portfolio limited to 2.5 times gearing has returned 55.5 per cent, with only one negative quarter.

If you are risk-averse but still prefer the DIY approach, Societe Generale’s listed CFDs allow you to bet on an underlying share or index. They are traded on the stock market and, like the IG Index product, have no margin calls and cannot lose more than you invest.

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