In 2015, I decided to get my 14-year-old into investing. The school year is busy, so we started in June. Over years prior, I had taught him the basics of investing. We went over the the definitions of stocks and bonds, and then moved on to funds. I explained the basics of valuation measures such as price-to-earnings ratios and how total return is the sum of dividends and price appreciation. In June of 2015, to make this real, I set up a brokerage account for him and funded it with a sum of money that, while fairly modest, seemed like a lot to him.
The next step was to decide how to invest the money. I explained that you can either invest in the entire market using a few funds (following John Bogle, the founder of Vanguard) or you can choose a specific theme or tilt for your investments. Some people invest based on what they know , an approach endorsed by famed manager Peter Lynch. If you are a doctor, you may have insight into promising technologies or therapies and invest accordingly. For someone learning about investing, choosing a theme makes the process much more interesting. And, of course, you don’t have to do one or the other. Many investors choose a combination of a core allocation to a few funds and a portfolio of individual stocks selected using their expertise.
One of the the central themes of my approach to helping my son to build a portfolio was that, as long as you spread your bets broadly and don’t get greedy, you will do just fine even if your theme or tilt does not work out as you expect. This is the essence of risk management.
One alternative that I suggested, the one that he chose, was to invest on the basis of El Nino, a topic that was much in the news that year. We gathered articles on El Nino and its economic impacts and then thought about different parts on the global economy that are impacted. El Nino impacts food production, transportation, demand for energy, and insurance. El Nino also impacts some commodities such as coffee beans. On the basis of a modest amount of work, we decided to invest in a number of individual stocks and a few funds. This level of analysis can be accomplished in as little as a few hours–about the same amount of work as a short research paper for school.
The investing theme can be anything that the teen finds interesting, as long as there are implications across a range of industries. So, for example, video games are not sufficiently broad but artificial intelligence (AI) would be.
As it turned out, there was no obvious boost to the performance of our El Nino-themed portfolio. The biggest lesson was simply that the portfolio did just fine anyway. The theme gave us the basis to select stocks and sectors. The resulting portfolio was invested across a range of sectors and markets and the performance reflected this.
For the year after we built the portfolio, we mostly ignored it. We’d check in occasionally but we never bought or sold anything. In the ensuing years, we sold the coffee ETF and a few other investments that were more targeted to El Nino, but we have done very little. We have probably executed two trades a year since the end of the first year. And this was another of the big lessons. Being an effective investor does not mean that you trade frequently–quite the opposite. In general, the more you trade, the worse you do. So, we check in every now and then and the portfolio is ticking along and growing fairly steadily, although we saw it drop substantially in late 2018 and then recover nicely in 2019.
Another of the important lessons in this process is that you will have to get comfortable riding out the swings, although they don’t bother you if you don’t look at the account much. Eventually, of course, we will get a real bear market and this all-equity portfolio will take a big hit. But that’s also part of the process and we will just stay invested in a wide range of companies and let things recover.
This approach to exploring investing really demystifies the process. The benefit of having real money on the line is that you get to experience the ups and downs in concrete terms. Paper trading and investing games get you only so far. This process will work just fine for adults, too, and is pretty much the process that I went through when I learned about investing in my twenties.
Geoff Considine on Finance and Economics 