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Investors’ best friend?

Investors have the memory of the bear market at the forefront of their minds. Is this caution justified? asks Brian Tora.

With February now upon us, this is the time when financial advisers start thinking about year-end tax planning. There will be plenty for their clients to do. Looking at taking profits on investments to utilise the annual capital gains tax allowance is one clear example and there are other exemptions of which investors can take advantage. Making certain pension contributions are up to date and taking out a 2004/05 Isa should be high on the list of priorities – except that investors these days seem unwilling to commit money to the stockmarket.

According to figures published recently, last year saw record amounts of cash flowing into building society savings accounts. The net inflows were nearly double the levels achieved in 2003 and brought the total held in these accounts to the highest level in seven years. If this was not enough of an indication that investors have become wary of the stockmarket, then the fact that net sales of equity Isas have fallen to their lowest level since they were launched in 1999 certainly provides confirmation. Yet during the last quarter of 2004 we had positive stockmarket returns.

That enthusiasm for investing appeared to wane as the new year commenced is clear from the way in which the index has behaved since the start of January. Shares are moving relentlessly sideways. The picture being painted of the domestic economy is as confusing as that emerging in the rest of the world. Retail sales were clearly disappointing over Christmas and the housing market, if not exactly in reverse, has certainly cooled. Yet none of this indicates an approaching economic crunch, rather it appears that the mild excesses that were building in the system are easing. This is a set of circumstances for which we should all be thankful but investors still have the memory of the damaging bear market at the forefront of their minds. Is their caution justified?As it happens, not everything in the garden is rosy. The percentage of first-time buyers in the housing market is depressingly low, showing that the rise in house prices has rendered access to the housing ladder impossible for many. The level of Government borrowing is also a concern although good tax revenues during December have brought the overall figures more in line with Chancellor Gordon Brown’s forecasts. Even so, tax rises could be on the horizon once the general election is out of the way.

Moreover, employment and inflation figures published last month support the case for maintaining a tight monetary policy. The housing market may be less of a problem but elsewhere the approach of the Bank of England appears to have been vindicated. Even though interest rates are significantly less than in Europe or the US, those who were hoping for the next move to be down will probably have to wait a little longer.

Investors, as a consequence, are wondering how much ground the market can make during the current year. After all, 2003 may have represented a bounce from an oversold position but 2004 felt altogether harder work. Valuation levels may not be as stretched as five years go but shares are hardly a steal either. Overall, investors appear right to be cautious, even if downright pessimism would seem misplaced at present.

To return to year-end tax planning, at least we have another year when balancing gains and profits should not be too much of a problem. Indeed, we now have two years of positive markets in a row. As to whether Isa contributions should be made – that is a less easy call to make. Many of the tax advantages end when this tax year finishes but the fact that any capital gains made are not subject to tax, and the knowledge that Isas do not have to be entered on to a tax return, must carry some weight.

The money that flowed out of the equity market during 2004 may well have missed out on the year-end rally. A repeat of positive markets for 2005 is certainly not to be dismissed, even if we should all moderate our expectations. In the long run, though, building up a tax-free fund, like an Isa or a pension plan, must make sound sense. We should all be long-term investors if it is in the equity market we are seeking to put our savings.

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