Any successful, seasoned investor would agree that the most important resource you can have with investing is time.
It is our most inflexible, yet valuable commodity. In investment, time means compounding, and the compounding or growth of investments is where real wealth is created. Starting early could be one of the greatest lessons you can offer your children.
A simple example – open a bank account for your children and each week deposit $10 for their pocket or chore money. On top of that, you can add any birthday or Christmas money and encourage a bit of healthy competition to see who can maintain the bigger account balance.
After about 5 or so years, you’ll find your children have a healthy balance of a few thousand dollars and they will be ready for the next phase of education – investing in shares.
Our Senior Investment Advisor – Mike Cooney – took this approach with his children to show them the impact of long-term compounding. He asked each of his children what they thought was a great company and they immediately replied, Apple and Google. As Mike was planning this to be a decade long exercise, he was impressed with their responses.
Apple pays less than 1% per year as a dividend and Google which is listed under its parent Alphabet doesn’t pay a dividend at all, its dividend yield is zero. When considering a decade long investment at the ages of 8 to 12, income from dividends is not important, in fact it’s a deterrence.
A key metric used in portfolio management is the ratio, “return on equity” (ROE). ROE is a measure of what return a business generates on the equity invested in the business. For example, if you invest $100 to start your own business and earn $25 in your first year then your ROE would be 25 percent. If you took that $25 out at the end of the year and just put it in the bank, you would earn roughly 0.5% percent interest on that money. But if you have a business that can generate a ROE of 25 per cent per year after year, it means the profit is being recycled back in the business so that ROE can stay right where it is.
Apple currently have a ROE of 82 per cent which of course is largely factored into the share price. When Mike’s daughter bought Apple shares in January 2019 many predicted it had reached its peak and the iPhone was over saturated. However, with that “return on equity” Apple developed their wearables business, Apple Watch, AirPods and Beats. These alone in 2019 generated over $20 billion in revenue, making it bigger than McDonald’s. If Apples wearables business was spun out, the business would likely be one of the 20 most valuable firms in the world.
It took Apple 42 years to reach $1 trillion in value, and 20 weeks to accelerate from $1 trillion to $2 trillion (March to August 2020). Apple is now getting nearly half its revenues from something other than the iPhone.
Mike’s other child who invested in Google has not had the same success, but it is still a sound selection when looking at the long-term. The Google-Facebook duopoly’s share of the digital ad market is predicted at 61% in 2021, Google taking the lion share of that 61% with digital advertising set to grow by 40% this year. But Googles search algorithm is only one of the many reasons to like the stock. It owns YouTube which has 82 years — yes, years — of new video uploaded every day. They have also been working on their own car, Waymo which is autonomous taxi service currently servicing Phoenix, Arizona.
Mike’s family is only two years into a decade long experiment and clearly having an investment adviser as a father has helped. The next step in their lesson is diversification, as their bank balances are currently building again. Investing over the long-term pays out, but there are always dips along the way. Diversification protects you — with it bad decisions will still hurt, but they won’t prove fatal.
The day to day frenetic buying and selling, the concerns over the economy and bad news are always with us. When you help your kids start investing it forces you to extend your time horizon. You don’t put anything in your kid’s portfolio can you don’t think is a good 10-year investment.
When investing for a child it is also important to understand the rules and taxation outcomes which include income and any future capital gains tax.
In Mike’s case, he opened an account with an online brokerage. As you cannot trade on behalf of a minor, you can however open an account in the name of an adult who will act as trustee until the child turns 18. Once your child has turned 18, the shares can be transferred into an account in their name and can then be free of the high taxation levels of minors and utilise the capital gains tax concessions offered to adults. This will be another step in their education as they will then receive the brutal lesson of taxation.
Finally, make sure you get your children involved, this is a chance to teach them so much about the value of time and good stock selection. Most of all, it should be fun, don’t make them buy something they have no interest, listen to them, and they’ll probably surprise you.