My son is now a teenager, and we are in the ‘teaching life skills’ phase of parenting. His wonderful aunt recently gifted him a small amount of stock into a custodial account which seemed like the perfect opportunity to start on the journey of understanding investing and personal finance. I so badly wanted to foster excitement and personal investment into the process that my instinct was to throw away the principles of investing that I deeply believe in and espouse every day in the hopes that he would find the process more interesting and relatable.
That should not have been surprising because I see that same thing with my clients when they are helping their children or grandchildren. I don’t believe the road to success comes through picking individual stocks or picking winners over losers in any context. Why is it then that my instinct was to educate him about stocks and bonds and then encourage him to choose a few companies he knows well and follows? Surely he would be more interested in investing if he owned stock in Apple that makes his phone or Microsoft that manufactures his Xbox? We are talking about a small amount of money, and they are great companies that should do well over time. Maybe even Bitcoin? I know I don’t want to own it, but if he hits it big then he will want to learn more. Unfortunately I don’t think it works out the way you want whether you choose well or poorly once you have the benefit of hindsight.
Imagine you choose well. You bought Tesla and Bitcoin a few years ago because they were exciting; you swung for the fences and hit a home run. What is the long-term lesson? Assuming you don’t intend to hold forever, then how do you make your next investment decision? What you are teaching is that success comes from picking the right thing and avoiding the wrong one. We would never manage our retirement that way.
This is more than theoretical. I know a family that chose a few stocks when they were a young married couple in their early twenties. Those choices (Disney, GE, IBM etc.) did very well, but it also convinced them that they had some special skill in picking winners. They are now in their seventies and still chasing that high from forty years ago. Their portfolio had a period of strong outperformance early in their lives and has greatly underperformed over the last couple of decades and they have become concentrated in just a few companies. We know that professional money managers who have early success show no persistence in their ability to outperform so why would we expect that from ourselves or our children?
I know the consequences of making a speculative choice that doesn’t work out because I made that mistake when my wife Laurie and I were just starting out. She had just left her first job and needed to invest a couple of thousand dollars in her IRA. This was 1999 and the height of the tech bubble and, as far as I knew at that point, diversification meant owning a mutual fund with a variety of tech stocks rather than just buying one or two of them. We put all of her money in a fund that only bought tech companies. After the market declines of 2000-2002, it took well over a decade for that fund to get back to even. The monetary loss was, thankfully, not devastating, but it did impact how she felt about investing. People who face adversity early can feel that they are just not ‘good at this’ or that they just don’t know enough to be successful when that was never part of the recipe from the beginning.
So if you are looking to set up a small account for a child or grandchild how do you help them select investments differently than I did? Fortunately, the answer is both simple and effective. Success and the right lessons come from the same principles we employ when managing very large portfolios. You should:
- Not try to pick any one asset class or company.
- Take risk. When you are young risk is a good thing. You want to have your money in stocks for long term goals. Take advantage of that time frame.
- Diversify away your risk. Not only by choosing an index fund, but by choosing one that covers as much of the world marketplace as possible. For instance, Vanguard offers a fund that covers the entire world marketplace of tradeable companies. They offer a slightly narrower version that overs only those companies in the United States. Both allow you to participate in the growth of the great companies of the world without risk of choosing wrong.
- Get the next generation excited about the long-term effect of compounding. You don’t need to make outsized gains every year to be excited about saving. Most investors fail to get the returns the markets give us. If you can succeed in participating fully in the growth that is available, you can achieve amazing things.
We are happy to help you with these decisions or to set up accounts, but at ReFrame Wealth we truly believe that the principles we follow and the values we hold apply to everyone. You will adjust your level of risk based on your tolerance and timeframe, but the best results will still come from a disciplined process. I was reminded of that when my son asked how much was in his college account. It was twice as much as he thought based on when he asked a few years ago. The fact is that if you as an investor achieve just the returns the broad market gives you, you are likely to outperform about 85% of other investors. That sounds like winning to me.
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