Liquidity Trap

“Liquidity Trap” means different things to different people. The Financial Times published an insightful article on 25th January 2012 by Gavyn Davies, which can be found at http://www.ft.com/cms/s/0/343c763e-45a8-11e1-acc9-00144feabdc0.html
and is worth reading in full. But what does it really mean to the ordinary UK investor?

The article concludes: “liquidity trap conditions have left bonds looking extremely expensive relative to equities in the developed economies. Nominal equity returns may be held back by low inflation, but in real terms they should outperform government bonds, even if the liquidity trap deepens further”.

Many investors for whom a full equity ISA is appropriate have been steered towards bond funds to maximise the tax advantages of the wrapper, following the withdrawal of Income Tax advantages from ISAs for equities by the Chancellor of the Exchequer some time ago. Good Bond funds can offer better rates of return than the interest rates offered by Institutions on Cash ISAs.

The warning, that the Liquidity Trap may mean Bond rates will be low, highlights the case for investors to take advice from a good IFA on which Bond Funds to choose: both to optimise the rate of interest paid within the risk parameters you have chosen and also to use the funds most likely to continue to increase the capital value of the investment (or if the value of the investment goes down, to keep the loss to a minimum).

Further, investors should concentrate on the real rate of return after inflation. UK equities have historically had attractions in real terms (after adjusting for inflation) when viewed over a medium to long term (say, over 10 years). This is really only another way of extolling the case for a balanced portfolio tailored to your own personal circumstances and tolerance of risk. That said, some good equities offer better income than most Building Society or Bank Accounts. There are funds that are geared to investing in good income producing stocks.

No investment is risk free. Past performance is not a guarantee of future returns. Further, I expect considerable volatility in the stock market for at least the first half of 2012.

Keep your funds under constant review; or get your IFA to do so. It costs money to switch funds, because the Fund managers rely on their margin between the bid and offer prices. (On any given day of trading, you will pay more to buy a particular Fund than you will be paid if you cash it in.) If prices of a particular investment go down, you may be better to get out and re-invest in a better fund despite the transaction costs.

The ultimate lesson may be to learn that it is better to have a good IFA than follow your own hunches, and to pay him a fee for the time he spends, rather than have him rely on commission paid by the Institution that runs the fund you buy and sell.

This is the opinion of Richard Briggs and is not intended to recommend any course of action. You should always seek independent financial advice

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