If you spend any time listening to the government and financial analysts reporting on the economy in the media, you will have no doubt heard the words GDP (gross domestic product), CPI (consumer price index/inflation), austerity, prosperity, recovery, growth and many, many more possibly wondering why it is all so important.

In this article we look at why the UK economic outlook is important, along with the impact of European and world economies, where we’ve come from and where it’s going and how it can impact on your finances.

So what’s it all about?

We need our economy to be strong, but unfortunately, managing the UK economy is not an exact science and with dependencies on other economies around the world, it isn’t totally within the control of our government either.

As you will have seen from the downturn in 2009 which impacted every developed economy throughout the world to some extent, the dependencies we have on each other are crucial to helping the UK remain competitive and robust against any issues that may arise in the future which could negatively impact our own welfare.

Investopedia definition of ‘Gross Domestic Product – GDP’

“The monetary value of all the finished goods and services produced within a country’s borders in a specific time period, though GDP is usually calculated on an annual basis. It includes all of private and public consumption, government outlays, investments and exports less imports that occur within a defined territory.”

GDP is one of the key measures of a country’s economy and looks at varying factors as outlined in the description above to come to its overall conclusion, such as the performance of our industry and services, employment vs unemployment, welfare costs, how much we spend vs how much we bring in and the value of our pound alongside other currencies.

A good source of information as to the state of the economy is the Office for National Statistics (ONS) Economic Review 2015, published on 3rd June 2015.

How do we determine the current state of the UK economy?

In order to determine the current state of the economy, we need to understand the business cycle; four different periods of activity extended over several years. These phases can differ substantially in duration, but are all closely intertwined in the overall state of the economy:

Peak – Employment is at or near maximum levels, gross domestic product (GDP) output is at its upper limit and income levels are increasing. This tends to be good for investors.

Recession – Income and employment decline. Recession is loosely defined as two consecutive quarters of decline in GDP output.

Trough / Depression – A sustained economic recession, in which output and employment eventually reach an all-time low.

Expansion/Recovery – Employment, production and income all start to undergo a period of growth and the overall economic climate is good.

Why does understanding the economy matter to your finances?

Understanding the business cycle doesn’t matter much unless it improves portfolio returns. What’s an investor to do during recession? Unfortunately, there is no easy answer. It really depends on your situation and what type of investor you are.

Recession investors – The most experienced investors know how to potentially profit from a recession by selling their shares before they start to decline, this does however have pitfalls and may not the right approach for you. Knowing that better times will eventually return in the economy, “value investors” use the fact shares are declining as buying sprees – buying high-quality companies with cheaper share prices. While a follower of the long-term, buy-and-hold strategy knows that short-term problems are more likely to be a blip when looking at a 20-30 year investment horizon.

The key here is to understand your situation. If you are close to retirement, the long-term approach may not be right for you. Alternatively, instead of being at the mercy of the stock market, you could diversify into other assets such as bonds, the money market, property, etc. Understanding both the business cycle and your individual investment style is the key to surviving a recession and potentially maximising returns during periods of economic growth.

At Bridge Investments we can help you with the best course of action for you based on the type of investor you are and your personal circumstances.

The purpose of this article is to provide technical and generic guidance and should not be interpreted as a personal recommendation or advice

Angus Kirk

Financial Planner at Bridge Investments
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