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Investing lessons from youth

March 21, 2014
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By  Richard M. Rosso

Learn more about Richard on NerdWallet’s Ask an Advisor

“Kids say the darndest things.” —Tammy Wynette

It’s a sincere honor to teach future generations about money. Kids younger than 13 tend to be overly excited, prone to blurt out whatever is on their minds, often to the surprise of any adults in the room. I always make sure to have plenty of treats for everyone at the end. Since it was later in the day, the fourth-grade class that made the journey to the office recently was especially ravenous. Still, I wasn’t going to change the routine—we learn at the beginning, ravage the cakes at the end. And this batch of cupcakes was especially fresh and frosty. But it didn’t matter: I wasn’t going to deviate from the plan I’ve used for years.

Out of the mouth of babes, lessons and behaviors we’ve clearly forgotten. As adults, we are relentlessly bombarded with the noise of daily life, and because of our biases we sometimes don’t see things clearly. Children are overwhelmed with stimuli, too, but they don’t have as entrenched a filter and so are willing to see things as they are and happy to share an opinion. There are wise words coming from the mouths of babes, if you only listen. Here are a few simple rules:

1. Do your homework before you take action. Many of the kids believe that before you make an important purchase, you do your homework. Now, the kids’ idea of homework may not be as sophisticated as an adult’s, but investors tend to forget, especially when the markets are more erratic, that emotions can overwhelm the desire to dig into facts. We take action first out of fear or panic, and deal with the repercussions later. The kids always seem surprised how many adults will buy and sell investments based exclusively on what they see on television or hear on the radio. Mind you, these young students think it’s perfectly OK to purchase a breakfast cereal based on the media, but acquiring an investment or “something that can go down,” (their words, not mine) requires more time and effort.

During market extremes it’s timely to take your portfolio’s pulse (and yours) to determine whether you’re comfortable with your asset allocation plan—the division of assets into stocks, fixed income, cash and other investments. If you are uncomfortable because your portfolio is gyrating more than the market up or down, do your homework to home in on the investments causing the concern. From there, it’s time to decide (based on the homework, not heartburn) to take one of three roads as you evaluate financial holdings: stay the course, buy more or sell the investments causing you distress. Again, base these decisions on your tolerance for risk and then maintain that risk profile through good and bad cycles.

2. Buy low. I know this sounds flippant or simplistic, but for the mature crowd, buying low is easier said than done. The children believe they should try their best to buy low into investments, or at least they hope to accomplish this on a consistent basis. We preach patience when the kids want a new video game, it’s time we teach ourselves some patience and let asset prices come to us.

3. Buy what you understand. Another easy one, in theory anyway. The kids feel strongly about buying what they know or understand. Occasionally, we make a portfolio allocation too complicated by purchasing investments we don’t fully grasp. There are a plethora of vehicles available that are based on currency movement, bet against the markets or particular industries or promise appetizing returns when the market is directionless. But what will be their impact to your overall portfolio? If the addition appears overly complicated and you can’t explain it to a friend, you may be better off passing on it. A complicated strategy is not necessarily a better one. Your investment plan needs to be realistic, actionable and comfortable based on your personalized goals and aspirations.

4. A “sell” discipline, what’s that? Children seem to embrace the idea of selling investments and moving on. For some of us grown-ups, this can be a challenge. We tend to resist rebalancing or we allow one investment to swallow up a major portion of the portfolio, resulting in more risk. If you don’t have discipline around buying and selling assets to restore your portfolio to an original target allocation, ultimately you’re not controlling risk. Rebalancing requires a contrarian nature whereby you’re shaving down what’s done the best and adding dollars to those asset classes currently out of favor.

A concentrated position means that a stock, industry or sector makes up a disproportionate share of your total portfolio, usually 20% or more. The end result is more volatility in the portfolio; the key driver of returns, good or bad, is the performance of a large holding. Investors are sometimes reluctant to trim concentrated positions due to the tax implications of a large capital gain or an anchoring to a past price to minimize a loss. It’s important to maintain perspective on the risk as first priority.

5. Wait patiently for cupcakes at the end. Investing requires patience and discipline. You must establish goals, and when those goals are met, the sweet reward is sure to follow. It was tough for the kids to focus on the lesson at hand with treats waiting; they eventually learn that shortcuts to the baked goods don’t exist, especially through my lessons! It’s similar with investing. We too want our dessert first, or seek to get rich quick based on shortcuts. When the markets are not cooperating, back-to-basics strategies such as saving more, decreasing debt and extending the time needed to reach a financial goal are usually the best.

What will you learn from the children today? Keep an open mind and you might be surprised.