“Oh, you are a stock market guy? I’d love you to talk to my son Johnny. He is really interested in investing. When he was a freshman in high school, we set up a brokerage account for him. In the last two years, he’s made money on Apple, Nike, Target, and other companies he knows about. I think he may have a future. What stocks do you like so I can have Johnny look at them?”
Most of us in the investment business have had this conversation, on the soccer field, at a school play, or with some friends. A proud parent of a stockpicker prodigy believes there may be some chance that their offspring is the next Warren Buffett and wants to give every resource to fuel their child’s investing passions.
Sorry, mom or dad, but it is more likely that you are turning your child into a gambler than an investor.
Just because your kid has a pair of Nikes or an iPad doesn’t mean he knows a thing about the companies in which he’s invested or how to analyze them, let alone has an edge against the billion IQ points of professional traders.
Facts show that over time, most professional stockpickers can’t beat their benchmarks. And neither will Johnny. Being a great stockpicker carries low odds, plenty of losses and takes thousands of hours of work.
If your child does have an interest and some capital to invest, consider putting on some “training wheels” before getting onto the investment bike.
1. Safety Manual. Have her read “The Elements of Investing” by Burton Malkiel and Charles Ellis. This is like taking a bicycle safety course so that Suzie understands the hazards of investing and how the deck is stacked against her.
2. Training Wheels. Let your child start understanding how broad markets run by watching him ebb and flow based upon real world events. Open up a brokerage account, and have Johnny purchase equal amounts (20%) into these five Vanguard exchange-traded funds (ETFs): Total Stock Market (VTI,) Emerging Markets (VWO), European Stocks (VGK), Pacific stocks (VPL) and Total Bond Market (BND).
This portfolio equates to an “aggressive” asset allocation, right for a young person who has no need for the capital for the next five to 10 years.
3. Observe and Discuss. Watch how U.S. events impact the Vanguard Total Stock Market ETF, which has over 3,300 U.S. stocks like Apple, P&G, and Pfizer.
As emerging markets move, so will the Vanguard Emerging Markets ETF, which encompasses 900 companies in 28 countries including Brazil, Russia, India, China.
Owning the largest 450 companies in Europe with the Vanguard European ETF will show the developing problems and solutions within the European Union.
Owning the Vanguard Pacific ETF will show how Asia moves and the 450 companies in Japan, Hong Kong, and Australia.
And when these four funds drop because of the world-wide panic of the day, discuss why the Vanguard Total Bond Market ETF rises as investors run for safety in bonds. Discuss why he is losing money in stocks.
4. Make Some Calls. As Suzie starts seeing how world news impacts her portfolio, see if she is developing opinions. If so, have her express these by changing the weighting. If she thinks Europe is going to fall into a black hole, she may want to rebalance Europe down to 10% and add to others. Doing this will allow her, in the safety nest of index funds, to make mistakes without getting hurt too bad, or make a good market call. She may find that she is wrong as much as right.
5. Dive In. If Johnny still insists on taking off the training wheels, then have him buy a few stocks. But make sure to benchmark them against the ETF that applies. If Johnny buys five U.S. stocks, see how they do together against VTI and so on. Most likely, if Johnny owns 10 stocks or more, they will “ride” the overall market, and he can decide if all the work to pick a stock is worth the trouble.
With any hazardous sport, you begin with preparation. Investing is no different. Show your child how markets run using index ETFs, before starting to pick individual stocks. You’ll raise an investor, not a gambler.