Why 2013 Could Be a Year of Strong Economic Growth

2013 could bring strong economic growth to the U.S. because U.S. Banks and the Federal Reserve are now creating near-normal amounts of credit, which will stimulate domestic demand. This was the prediction made by Dr. Paul Kasriel, retired Chief Economist of The Northern Trust Co., at the January meeting of the San Francisco Financial Planning Association.

Dr. Kasriel believes there is a very strong correlation between Gross Domestic Product growth and bank credit growth. This is good news because the growth in credit for the U.S. has reached 5% annually, the same point it reached in 1994 and 1995, which preceded five more years of strong economic expansion.

The U.S. banking system operates with a fractional reserve monetary arrangement so that depository institutions (banks) can create an amount of credit that is some multiple of the amount of “seed” money (reserves) provided by the central bank. Dr. Kasriel asserts that banks use reserves to expand credit by a 10 to 1 ratio ($100 of reserves for every $1,000 loaned out). This credit, created by the depository institution, is essentially credit created figuratively— in other words, out of “thin-air.”

“Thin-air” credit is very powerful because the bank making the loan does not need to cut back on current spending, while the recipient uses the loan to increase spending. An increase in this type of credit will result in a net increase in nominal spending in the economy. A recovery in “thin-air” credit coincided with the vigorous economic recovery that brought the U.S. out of the Great Depression in the 1930’s.

With inflation abating in China, the Chinese central bank will reduce short-term interest rates, resulting in faster growth in Chinese “thin-air” credit and domestic demand. The acceleration in Chinese domestic demand will positively affect the international exports.

2013 could bring strong economic growth to the global stage as well.

Top Six Investment Mistakes

In working mostly with individual investors, we witness firsthand how people manage their investments and think about money. Most importantly, we are able to see what works and what doesn’t—the behaviors, attitudes, and decisions that make clients’ financial plans stronger and those that reduce the likelihood of reaching their goals. In this week’s blog entry, we are presenting the worst mistakes that we have seen clients make over the last 21 years—ones that are common, frequently repeated, and worst of all, detrimental to being a successful in managing your investments.

1. Market Timing

Market timing is the act of moving back and forth between stocks and cash. While the idea is good in theory (i.e. stay invested in stocks while they’re appreciating and move to cash when stocks are depreciating), it simply doesn’t work in practice. There are countless academic studies that measure the success of investors’ ability to time the market, and we’ve never encountered one that suggested that the practice was anything but disastrous to long-term returns. However, while we can get market-timing investors to acknowledge this fact, it can be very hard to break people of this bad habit.

Rather than cite all of the research that proves market timing doesn’t work and bore you into a state of unconsciousness, let’s keep it short and simple: investors move between stocks and cash for two emotional reasons—fear and greed. No one likes losing money; it can be scary. Therefore, when investors see the value of their stocks declining, they are often triggered to sell and sit in cash until things get better. Why not just avoid investments that can lose money? That is where greed comes into play. When stocks are appreciating, everyone wants to participate to make the “easy” money.

Making buy/sell decisions based on emotional triggers is obviously a poor strategy and one of the reasons why market timing doesn’t work. But the key reason for why it doesn’t work has more to do with the fear than the greed. Investors sell out of stocks when they’re falling because they’re afraid of losing more money. However, unless they buy back into stocks when they are at a lower level (and presumably when the news is a lot worse), they are setting themselves up to sell low and buy high, which is the exact opposite of what successful investors do. In over 20 years of watching people attempt to time the market despite our advice, there exist very few people who can buy back into stocks when they have fallen further amidst increasingly dire financial news. Unless you’re positive that you are one of them, don’t attempt to time the market.

2. Taking More Risk than You Can Stomach

When meeting with new clients, we go to great lengths to understand their tolerance for risk and to subsequently put them into a portfolio that they will be comfortable with, even in the worst economic times. It’s an essential task because when investors take more risk than they are truly comfortable with, emotion will take over when things start to get bad, and we don’t want our clients making emotionally-driven investment decisions. That leads to market timing, selling low, buying high, and poor long-term returns.

To determine a client’s risk tolerance we inquire about their past investment experiences—the types of investments they’ve made in the past, the worst losses they’ve endured, and how those experiences made them feel. Then we show them a number of portfolio combinations, and we include not just the historical and expected returns but the worst losses each portfolio has experienced in the past. We know from history (and recent experience) that the stock market can lose 50% of its value; if you are unable to watch the value of your investments get cut in half without getting an overwhelming urge to sell, then a 100% stock portfolio is not right for you.

3. Watching CNBC

First, let us say that we encourage all of our clients to be informed investors, which is why we fill our website with educational content like these blog posts. But it’s important to understand the difference between information and infotainment. Quality information is objective and unbiased. Both sides of any issue are presented so that you can make up your own mind. And quality information is provided without sound effects, flashing graphics, and histrionics. Watch CNBC for any length of time, and you’ll find that the station offers none of those things. (For a point of contrast, watch an episode of Nightly Business Report on PBS, an informational show that investors should be watching.)

Additionally, CNBC is on 24/7. They need content and lots of it to fill all of that time, which results in information overload for the viewer, as every piece of news and economic data is dissected in dizzying detail. More information is not always a good thing. It can lead to decision paralysis, a short-term focus, and riled-up emotions, none of which helps you become a successful investor.

4. Ignoring Inflation

The famous economist, John Maynard Keynes, coined the term “money illusion” long ago to describe the fact that investors tend to ignore inflation in their decision making. Fast forward about 100 years and little has changed. We see investors ignoring inflation all the time.

Inflation is the increase in the cost of goods and services over time. Historically, it has averaged about 3% per year, which means that the product and/or service that you bought last year tends to cost about 3% more today. Over long periods of time, it will cost significantly more, so inflation costs you money in the sense that dollars that you are holding today will be worth less in the future. If you want your money to hold its value, it has to be invested at a rate at least equal to that of inflation. With interest rates on cash deposits close to 0%, we see many investors who are losing money on the value of their cash without even realizing it; yet, we’ve never seen an investor panic due to losses in purchasing power like they do with market losses. It’s because they simply don’t see it.

5. Assuming a Good Company = Good Investment

The legendary mutual fund manager, Peter Lynch, of the once-famed Fidelity Magellan Fund has always encouraged investors to own what you know—that is, buy stock in companies that you’re familiar with (i.e. the stores you shop at and the makers of the products you use). That is solid advice, but we often see it backfire as investors assume that a good company automatically equals a good investment.

You and all of your neighbors may love that little hole-in-the wall breakfast place down the street—the one that always seems to have a crowd waiting for a table. But if the owner of that restaurant offered you a 1% stake in the company for $1,000,000, you would probably pass and for good reason. Overpaying for a company leads to lackluster returns. Before buying any company, even one that we all consider great, you have to consider the price, especially as it relates to sales, earnings, cash flow, assets, and future growth potential. Successful investors don’t ignore those things.

6. Investing Based on Your Political Views

Politics and business are intertwined. There’s no doubt about that. Decisions by lawmakers in Washington and at our state and local levels have an effect on the bottom lines of businesses, which matters to you as an investor. However, we often see investors make investment decisions based solely on their political views, such as choosing to buy/sell stocks because a particular party is in office. That’s the wrong approach. While stocks have historically done better under Democratic leadership versus Republican leadership, there is no guarantee that will hold in the future, and it is not as if stocks have lost money historically with a Republican in office.

Rather than using your portfolio to cast a vote of confidence or no confidence for the party in power, use your portfolio to cast a vote of confidence for good, quality businesses. These companies are talented, innovative, smart, and dynamic; they will adapt to whatever is thrown at them, including government policies that you find absurd. Just make sure they’re not overpriced.