A Gift for Everyone : Investing Know-How
A Wise Graduation Gift: Investing Know-How
In recognition of the high financial costs of fatherhood, this year I’m giving my son a new kind of graduation gift: a small brokerage account and tips on how to use it. Here’s my plan.
By Jon Markman
(Originated from http://articles.moneycentral.msn.com/Investing/SuperModels/AWiseGraduationGiftInvestingKnowHow.aspx)
Now that the warm glow of Father’s Day has worn off, it’s time to come clean on how dads really view their sons.
In my heart of hearts, I know that one day the teenage omnivore who wished me a happy Father’s Day from the dugout of a windswept baseball field in eastern Washington last weekend will become more than the sum of his genetics, education, coaching, parenting and quarts of Gatorade. He will be a friend, a partner, a lifelong guide to the unexpected.
But for now, he sure seems like a financial black hole the size of Yankee Stadium. There are plenty of short-term and long-term psychic rewards from all that we invest in our kids, yet let’s face it: A 14-year-old is where $20 bills go to die.
In recognition of this impoverishing aspect of fatherhood, I decided to forgo a traditional eighth-grade graduation gift for Joe this month and instead open a brokerage account for him. In around 10 years, he’s going to have to be financially independent, so he might as well start to learn now how to leverage the capitalist system to his advantage.
A small sum and a contradiction
As I got to thinking about his account, which will start with $500 from my wife and me, $200 from my mom and $100 from an aunt and uncle, I realized that his predicament is similar to one faced by many readers. You’ve got $500 to $1,000 to invest. You want to preserve that capital, because it’s all you’ve got, but you want it to grow, too. That’s a contradiction, because to get that money to grow, you’ve got to put it at risk. So what’s the best way to get started?
Here’s the plan I’m putting together for my son and which I’ll pursue for my 12-year-old daughter when she graduates from middle school as well. It’s focused on beating the market, because we’re competitive and stubborn, but doing so in a prudent way that combines a spark of their tastes, view of the future and risk tolerance. I’ll encourage Joe to aim high, at lofty 15% annual pretax returns, but not to feel disappointed if that doesn’t happen. The goal is to steadily create an investment account worth $100,000 by the time he turns 30, first using parental gifts and then his own savings.
Keep costs low
My first recommendation is to keep costs as low as possible, and that means he needs to steer away from high-expense mutual funds and keep trading to a minimum. I am suggesting he start with three exchange-traded funds for 80% of his money, and two stocks for the remaining 20%. At $9.95 per trade at Schwab, his positions will cost $49.75.
That puts him 6.2% in the hole right away, which is pretty scary when you’re trying to make 20% a year. It also teaches a valuable lesson about how hard it is to make up a deficit — and why you always want to try to keep losses small. If you want to make 20% on $800, after all, your goal is to end the year with $960. But if you start with a $50 deficit, now you’ve got to earn 28% to get to $962. That’s a lot tougher.
Reams of academic research show that costs are a key reason investors underperform the market. Another reason, though, is that investors tend to hold too much cash when the market is rising because it is human nature to fear a downturn and thus hug a safety blanket. My experience suggests it’s hard to time the market’s ups and downs well enough to justify holding cash, so my second recommendation is to put all his money to work within a month, in three chunks: the first and largest part right away, and the smaller parcels on any 3% to 5% broad-market declines.To beat the market over 12 months, you typically need to have your money in sectors and stocks that are beating the market right now. And it would help to develop a view of the future that is at least slightly at odds with the average investor’s view. The great hedge fund pioneer Michael Steinhardt calls this contrarian outlook a “variant perception,” and you can spend a lifetime in the business developing the ability to do it well. So my third recommendation is that he spends a few minutes a week thinking about what the world is likely to value most in 12 months but is undervaluing now. That’s a tall order at 44, much less 14, but it’s doable if you turn off your iPod and stop text-messaging for a short while on the bus home from school. There’s an exchange-traded fund to match every variant perception, so the next step is to visit the iShares, Powershares or ProShares Web sites and pick a handful. I’ll tell him to choose at least two that are handily outperforming the market now and at least one that is just starting to outperform after at least a couple of years of underperformance.
My fourth recommendation is leverage his intuition, experience and taste to determine the names of a couple of public companies whose products or services he’s most likely to patronize frequently over the coming year. It could be a retailer, an electronics or apparel maker or a ski lift operator. But it must spark a passion and customer loyalty that is unsurpassed by peers. Kids know when a trend is going to be a home run, so they need to trust their instincts.
My fifth and final recommendation is to learn how to buy stocks and funds when they are fundamentally cheap versus their prospects. This is the hardest task of all, but it’s a lot easier than hitting a curveball. As a rule of thumb, I’ll tell him to try to buy stocks whose forward price-earnings multiples are lower than their estimated two-year growth rate, and preferably much lower. This gives him two ways to win: first when earnings growth advances faster than the market expects, and second when the P/E multiple — which is the hidden lever behind stock prices — rises in tandem with investors’ increasing confidence in the firm.
If it looks like he will get with this program effectively — and keep up a 3.75 to 4.0 grade-point average — I’ve told him I will contribute regularly to the account every semester on an accelerating scale so that he can put a down payment on a home or seed a business by the time he turns 30 in 2022. This may sound generous, but it will actually be cheaper to do over time than in a lump sum 10 years from now.
If he’s actually able to average 15% a year, which is unlikely, and hits all the GPA milestones, he’ll have $100,000 — and more importantly a lifelong habit of investing.
| School period | Date | Contribution* | Gain ** | Total | |||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| End 8th | 6/18/2007 | $750.00 | $750.00 | ||||||||
| Mid 9th | 12/30/2007 | $300.00 | $56.25 | $1,106.25 | |||||||
| End 9th | 6/18/2008 | $300.00 | $82.97 | $1,489.22 | |||||||
| Mid 10th | 12/31/2008 | $400.00 | $111.69 | $2,000.91 | |||||||
| End 10th | 6/18/2009 | $400.00 | $150.07 | $2,550.98 | |||||||
| Mid 11th | 12/31/2009 | $500.00 | $191.32 | $3,242.30 | |||||||
| End 11th | 6/18/2010 | $500.00 | $243.17 | $3,985.47 | |||||||
| Mid 12th | 12/31/2010 | $500.00 | $298.91 | $4,784.39 | |||||||
| End 12th | 6/18/2011 | $1,000.00 | $358.83 | $6,143.21 | |||||||
| Mid-Fresh | 12/31/2011 | $500.00 | $460.74 | $7,103.95 | |||||||
| End-Fresh | 6/18/2012 | $500.00 | $532.80 | $8,136.75 | |||||||
| Mid-Sophomore | 12/31/2012 | $500.00 | $610.26 | $9,247.01 | |||||||
| End-Sophomore | 6/18/2013 | $500.00 | $693.53 | $10,440.53 | |||||||
| Mid-Junior | 12/31/2013 | $600.00 | $783.04 | $11,823.57 | |||||||
| End-Junior | 6/18/2014 | $600.00 | $886.77 | $13,310.34 | |||||||
| Mid-Senior | 12/31/2014 | $600.00 | $998.28 | $14,908.62 | |||||||
| End-Senior | 6/18/2015 | $1,500.00 | $1,118.15 | $17,526.76 | |||||||
| Mid-Grad School Yr1 | 12/31/2015 | $700.00 | $1,314.51 | $19,541.27 | |||||||
| End-Grad School Yr1 | 6/18/2016 | $700.00 | $1,465.60 | $21,706.87 | |||||||
| Mid-Grad School Yr2 | 12/31/2016 | $700.00 | $1,628.01 | $24,034.88 | |||||||
| End-Grad School Yr2 | 6/18/2017 | $700.00 | $1,802.62 | $26,537.50 | |||||||
| Mid-Grad School Yr3 | 12/31/2017 | $800.00 | $1,990.31 | $29,327.81 | |||||||
| End-Grad School Yr3 | 6/18/2018 | $2,000.00 | $2,199.59 | $33,527.40 | |||||||
| Year 1 Work | 12/31/2019 | $5,000.00 | $5,029.11 | $43,556.50 | |||||||
| Year 2 Work | 12/31/2020 | $7,500.00 | $6,533.48 | $57,589.98 | |||||||
| Year 3 Work | 12/31/2021 | $10,000.00 | $8,638.50 | $76,228.48 | |||||||
| Year 4 Work | 12/31/2022 | $12,500.00 | $11,434.27 | $100,162.75 | |||||||
| TOTALS | $50,550.00 | $29,539.98 |
* Family gift through 2018; personal earnings through 2022
* 7.5% per six months
Now without any further ado, here is the portfolio that my son and I developed for his first $800 investment. It’s a work in progress. I suggest that he review all of his positions, and rationales, at least once a month — and make adjustments as necessary.
Exchange-traded funds
iShares Total Market (IYY, news, msgs). This is a great way to benchmark your whole portfolio and make a bet that small caps and midcaps will slightly outpace large caps over the next year.
iShares S&P Global Info Tech (IXN, news, msgs). This group has lagged the market for the past couple of years, but is just now rounding into favor. It includes all top tech companies, including Microsoft (MSFT, news, msgs), Intel (INTC, news, msgs), Google (GOOG, news, msgs), Nokia (NOK, news, msgs), Taiwan Semiconductor (TSM, news, msgs) and Cognizant Technology Solutions (CTSH, news, msgs). (Microsoft is the publisher of MSN Money.)
iShares S&P Global Energy (IXC, news, msgs). This group has outperformed for four years and will likely remain in favor. It includes all major global energy companies in all sectors of the business, including major integrateds ExxonMobil (XOM, news, msgs) and Total (TOT, news, msgs), services provider Schlumberger (SLB, news, msgs) and refiner Valero (VLO, news, msgs).
Stocks
His top choices for stocks were sunglass and apparel maker Oakley (OO, news, msgs), athletic apparel maker Under Armour (UA, news, msgs), fast-casual restaurant chain Chipotle Mexican Grill (CMG, news, msgs), iPod maker Apple (AAPL, news, msgs), media giant News Corp. (NWS, news, msgs) and snowboard and skateboard apparel maker Volcom (VLCM, news, msgs).
He will start with Oakley. Now trading at $25, our estimate for 2008 is that it’ll earn $1.30 a share, about 15% more than consensus. At that price, the current price-earnings multiple would be 19. Contrast that with earnings growth around 25%, and it’s a buy for a growth-at-a-reasonable-price investor.
His second choice is Volcom. Now trading at $48.80, we think it will earn $2.14 in 2008, or about 10% more than consensus. That puts the price-earnings multiple at 22. Contrast that with a 25% earnings growth rate, and it’s good to go.
His other top choices are Apple and Chipotle, which I already own at much lower prices for him in his educational trust. Both are too expensive right now for new purchase. Apple you know about. Chipotle, well, when I wrote about the fast-food chain back in November, it was a screaming buy. But now its price-earnings multiple on our $2.58 estimate for 2008 is 33. That’s too high for a company growing at around 25%, so we’ll eat there but won’t put any new money in.
I’ll keep you posted on how the portfolio goes. And if you have any suggestions, let me know at my message board.
Fine print
Back at the start of the year, in my column on possible surprises for 2007, I mentioned that I liked tiny Fuel Tech (FTEK, news, msgs) for its technology focused on cleaning up emissions at coal-fired power plants. The stock got a big 17% boost on Wednesday after signing an agreement with a Hong Kong company to launch a joint venture in China. I said I was looking for a 70% gain on Fuel Tech this year, so we’re now halfway there.
To learn more about iShares exchange-trade funds, visit their Web site. … To learn more about Volcom, visit it on the Web. … To learn more about Oakley, visit its Web site.
At the time of publication, Jon Markman owned Apple, Chipotle Mexican Grill, Microsoft, Intel and News Corp.
This entry was posted on Sunday, June 24th, 2007 at 2:20 pm and is filed under Investment Pick. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.
