I suggested last week that if you want to be wealthy you should find what the wealthy are doing and copy them. Another step in following the wealthy is to avoid those areas that diminish your wealth. Some call these the “holes in the bucket.” One of the biggest holes is created by taxes. Few people enjoy paying taxes and the wealthy go to great lengths to avoid them because they are a constant drain on wealth. One tax few people consider, is what Warren Buffet called the “inflation tax.” As I have discussed inflation with countless individuals, I have become convinced few realize how devastating its effects can be on some investments.
 
The average inflation rate over the last 100 years is slightly above 3%*, so let’s use that number for illustration purposes. What that means in real life is if you have $100 dollars today, you will need it to grow to $103 next year in order to be able to buy the exact same items. If it only grows to $102 then you technically have more dollars, but you can buy less with them, so you have lost wealth. Now here is where people get confused and where it gets really ugly from my point of view.
 
Suppose a conservative retiree averages a 3% annual rate of return.  A 3% inflation rate would eat up a full 100% of their gains. Imagine the outcry if the Federal government taxed 100% of all investment gains. Even if an investor obtained a 6% annual rate of return, the inflation tax in this hypothetical example would be 50% of total gains. Once you understand the high cost of inflation, you realize why wealthy investors work so hard to diminish its effects.
 
The tragedy of the “inflation tax” is that it unfairly punishes those on fixed incomes and conservative investors who are just trying to protect their nest egg. The less money you earn on your investments, the higher percent of your gains the inflation tax will claim. For many in retirement sitting on bank savings type accounts, the inflation tax consumes more than 100% of their gains each year. By comparison, the federal tax that we worry so much about can seem small.
 
Inflation should be right there with death and taxes on the list of things you can’t avoid. Even worse, if you earn nothing you will pay no federal tax, but the inflation tax will take its share just the same. It can be the most regressive tax we face.
 
I mentioned last week that the wealthy invest for growth while the poor seek principle protection. Unfortunately, many guaranteed investments do not even earn as much as the current inflation rate. For those investors, the “inflation tax” over a long retirement can be particularly damaging, and possibly the worst tax they will pay. If you want to invest like the wealthy, do not make the mistake of diminishing in your mind the negative effects of inflation.

The rich, the top 10%, keep getting richer and the gap between them and everyone else keeps widening. Some say our flawed capitalistic system favors the rich. Would I get bombarded with ugly emails if I suggested that the lower 90% should learn from the rich and consider doing what they do?
 
A speaker at a financial conference made a bold statement that I have considered for many years since. He said, “Rich people get richer because they invest in growth assets like stocks and real estate. Poor people stay poor because they focus on principal protection.”
 
People have told me, “I lost money in the stock market so I got out.” I sometimes display a stock market graph that shows what happened after they cashed out and say, “As you can see, you didn’t lose money because you were in the market, you lost money because you got out.”
 
In an investment chat room recently a gentleman boasted that his financial advisor had put him in an investment that “had never lost me a penny” and that he also “had never charged me a penny.” He then went on to ridicule those who put their money in the stock market.
 
I hear this comment often and I get annoyed because it is based on half-truths and a poor understanding of the products involved. Does this gentleman really believe his financial advisor is running a charitable non-profit? I have bought many cars and the salesman has never given me a bill for his services, but I have no question who is paying his salary. All financial advisors get paid, and all of them get paid by their clients.
 
The “investment” the man described is an insurance product. An insurance company’s main focus is to protect against a loss, with any potential growth being secondary to that purpose. Insurance is not an inherently bad thing. I insure my business, vehicles, house, health and life. I pay a lot for insurance and rarely get anything back, but in the event of a loss, the insurer guarantees to assume the risk. I don’t expect the insurer to make me money, just keep me from losing it. So insurance is designed for “principal protection.”
 
We all like guarantees. Who wouldn’t love guaranteed jobs, healthcare, and investment accounts? But guarantees come at a price, and it is often more than you expect. In the simplest terms, with investing you either take some risk to obtain growth, or pay someone else to assume the risk for you, and in so doing transfer away much of your potential gains.
 
So, why do the rich keep getting richer? There is no single answer but I recently studied the Forbes list of the 400 richest Americans. Not surprisingly, almost all of them listed stock or real estate ownership as the source of their wealth. Not a single one credited CD’s, guaranteed annuities or any other “principle protected” investment. They must know something that the other 90% might want to pay attention to.
 
(There is no guarantee that any investing goal will be met.  Past performance is no guarantee of future results.  Talk to your financial advisor before making any investing decisions.)

Every year I do two days of recurrent flight training to remain proficient in my airplane. During the training, the instructor will simulate potential emergencies to see how I react. For example, he may pull a few breakers causing various instruments and systems to fail. If I am able to fly the plane safely under simulated stressful conditions, I have a reasonable expectation to be able to do so in a real emergency. If not, then additional instructions will be given.
 
I’ve often thought it would be nice to create a similar scenario for investing where a portfolio could be stress tested to see how it might survive a crisis. I would also love to see how the investor might handle a challenging situation.
 
As I thought about this recently, I realized that investors were actually given a great training experience during the final quarter of 2018 when the Dow Jones Average fell about 15%. Like a simulated crisis, this market dip was an opportunity to see how your portfolio might perform in a more serious market crash.
 
So, my question is, how did you do? How did your portfolio hold up under the pressure? Did it lose value and if so, how much? If you own stocks, those positions almost certainly went down but did you have other investments that went up, offsetting the losses? By honestly looking at how you did, you will get a good idea if you need to make changes before a real crisis hits.
 
In my responsibility for other peoples’ investments I have set standards that I follow that I will share here. (These are general guidelines as individual needs will vary.) When the Dow falls, I want to limit a retirees’ portfolio downside to no more than 1/3 of what the Dow lost. So in this case that would be no more than a 5% dip. Protecting the downside, positions the portfolio for a quicker recovery and is one of the keys to successful portfolio management. On the other hand, there may be some portfolios that did not go down at all. In this case the account may actually be allocated too conservatively. For most people a portion in stocks makes sense for long term growth.
 
The other area to look at is your emotional state. If you were overly stressed during the fourth quarter that may be a sign you need to reduce your risk level. Now is a perfect time to make that assessment.
 
My annual flight training is an extremely useful tool in preparing me to be safe if a real crisis occurs. This recent market dip can also be very valuable in evaluating how your investment portfolio would handle a real disaster. Take some time to review how you did and make adjustments if needed. A real crisis will come one day and when it does, this training period will be a great benefit if you use it wisely.

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I was in a store on Christmas Eve when a long time reader asked if I was having a heart attack over the record market loss for that day. I responded that if stock market movements gave me a “heart attack” then I am definitely in the wrong business. We talked about the difference between the stock market and the economy and I pointed out that both have been heading in opposite directions the past few months, but only one of them mattered to me. Ironically, the very next trading day on December 26th the stock market had its biggest point gain ever. So the question to ask is, who was right about the economic future, the sellers who drove the market down on Christmas Eve or the buyers who drove it up on the 26th? These two consecutive record days, each going a different direction, will be a topic of discussion in future college textbooks as the next generation is taught what matters and what does not when it comes to investing.
 
The computerization of the stock trading has essentially created two different markets. The first is focused on assembling a portfolio of great companies whose value is expected to go up over the next few years. The second is comprised of short term traders who don’t care what a company is worth, but merely seek to profit from daily market movements. The first group is focused on corporate earnings and economic growth. The latter seems more interested in what they read on Twitter® and how they think it might move markets.
 
The vast majority of investors I know are, or should be, in the first group. They want to own companies and profit from their growth. The challenge for this group, and what leads to “heart attack” comments, is that they often mistake the short term market movements for an indication of long term value. In a sense, they play into the hands of short term traders who make money off rapid stock movements and the fear and greed they cause.
 
I have studied the great investors of the last century and have been unable to find a single one that was a short term trader. As the great investor Peter Lynch once said, “I can’t recall ever once having seen the name of a “market timer” on Forbes‘ annual list of the richest people in the world.” And then Mr. Lynch gave the key that made him one of the greatest investors of all time. He said, “The time to invest is when you have money and the time to sell is when you need money.”
 
The national and world economies continue to grow and with technology opening up huge untapped markets, I can’t think of a better time to be an investor. But if you are going to invest, make a new years’ resolution to stay in group one and don’t allow those in group two to pull you into their short term trading trap.

As investors have been hoping for a little something from Santa Claus this year, a 1983 Anne Murray song, “A Little Good News” might seem appropriate. In her song she complains about the daily barrage of media negativity and suggests how nice it would be if just one day the headlines read, "Not much to print today, can't find nothin' bad to say.” I chuckled as I reread her lyrics and realized not much has changed in 35 years.
 
The barrage of negativity continued after the meeting of the Federal Reserve this week, which was accompanied by another drop in stocks. I read the speech by Chairman Powell after the meeting hoping to find what all the fuss was about and here are some highlights.
 
He mentioned that the U.S. economy remained “healthy and solid.” Hmm, that didn’t sound like bad news to me so I kept reading. Powell then predicted the GDP growth rate for the economy in 2019 would be 2.3%. Once again I was scratching my head. Economists say an ideal growth rate is anywhere between 2 and 3%. So with the Fed predicating an “ideal” rate, why the complaining? Have we so quickly forgotten how thrilled we were in 2017 when GDP hit 2.2%?
 
This year growth will surpass 3% so maybe that is the real problem. Maybe investors have become like the spoiled kid who gets a pony for Christmas and then the following year complains when he only gets a new bike.
 
Powell went on to say the Fed expected unemployment to continue going down, wages to go up, and inflation to stay in check. This was all great news, but investors remained unimpressed.
 
Finally, Powell announced that due to the continued strength in the economy, and in order to keep a lid on any potential inflationary pressures, the Fed would likely raise interest rates two more times next year bringing the Fed rate by year end 2019 somewhere near 2.75%. The markets seemed unhappy with that announcement.
 
So let’s turn back now to Anne Murray’s song, and 1983, for a little perspective from an investor point of view. Despite Miss Murray’s gloomy lyrics, the Dow Jones average that year ended up 20%. Apparently Anne was not an investor or she would have been singing a different tune. What is remarkable is that the Fed rate that year ended over 9%. Such a rate would likely cause widespread panic today. Maybe 2.75% only looks bad because last Christmas Santa gave us 1.5%. Could this be another case of investors acting like spoiled children?
 
So the economy is strong and indications are that the strength will continue, yet investors continue to complain and sell their stocks at increasingly lower prices. It appears that any hopes for a gift from Santa is unlikely. But wait! Did I just say stocks are getting cheaper? Maybe Santa really has brought a gift for investors this year after all.
Merry Christmas!!

When I was quite young I read a great book by Robert Ringer, “Winning through Intimidation.” The book contained some amazing information about negotiations, and how to win them. As I have watched President Trump over the past two years I wonder if perhaps he may have read Mr. Ringers book as well.
 
One principle Ringer taught was that the winner in almost every negotiation is going to the person with the least commitment to the outcome, or the person with the least to lose. He points out that wealthy individuals usually come out on top in negotiations because they don’t need the deal as much the person they are negotiating with. In short, Ringer teaches to always be the person who can walk away.
 
The stock markets have been pretty volatile lately due to several issues, but one of the most concerning to investors seems to be the so-called trade war with China. President Trump and Mr. Xi are involved in negotiations over trade practices, with each side claiming the other is being unfair, and threatening to impose additional tariffs if they don’t get their way.
 
There is legitimate concern on Wall Street over this issue since trade with China is important to our economy. Many companies, largely technology, have big plans for Chinese expansion and the current battle has significantly damaged their share prices. As I have analyzed the risks to both sides in this “war,” I have felt to look past the political posturing and focus on the hard numbers. So here they are.
 
According to the US Census bureau, the last time we had a trade balance with China was in 1985. Since then there has been a significant imbalance. So far in 2018 the U.S. has exported $103 billion in goods to China while importing a whopping $445 billion. The Chinese market accounts for only 9% of total U.S. exports so it seems clear that China has far more to lose if this trade war is not resolved. They need this trade deal more than the U.S. needs it.
 
I am confident President Trump has done the math on this and realizes he is in a powerful negotiating position.  We don’t want a trade war with China, and they don’t want one with us, but with much more to lose I am confident China’s leaders will do what needs to be done to resolve this issue. I am also confident president Trump does not want to drag this out longer than necessary and will be open to a negotiated solution that “improves” the U.S. position.
 
If the stock market gets its Santa Claus rally this year, I believe it will be driven by hope for a resolution of the trade war with China. If that happens I would look for tech stocks to lead the way as they have been the hardest hit over this issue.