Several years ago, when my first niece was born, I set up a custodial brokerage account as a place to set aside the small monetary gifts that she received from excited family members. No time like 0 to 3 months to plan for college, right?
The initial intent had been to park the money in a conservative no-load mutual fund and forget about it. After all, with a small account size, there are limitations on the ability to diversify or rotate holdings of individual stocks. However, after some lousy under-performance in DODGX in '06/'07, I decided to reconsider individual stock selection for the account. In doing so, I set some ground rules:
- I'd need to diversify across at least 5 - and preferably 10 - holdings to have anything approaching diversification
- At that size, even modest discount brokerage commissions would take a big bite out of the funds, so I'd need to be confident that I'd be comfortable holding for the long term (which, to me, means 3+ years)
- None of the investments could be particularly speculative. Who wants to be the guy who "goes to Vegas" with their 5 year old niece's savings? I'm sure there's a special place in hell reserved for those kind of people.
- All of the stocks had to be things that I could explain to a child - and that they could understand. Half of the motivation to take on the extra risk and effort of picking stocks is so that, in a few years, my niece(s) will have a motivation to learn about the markets and a context in which to relate to them.
The funny thing is, as someone who struggles to sit tight with investments (read: cut losses quickly or take profits and run) I've gained a lot from the decision-making process. It's taught me to think about the soundness of the underlying business rather than relative valuation, and explaining to myself what the company does to generate value. In that way, it has gotten me to think much like a mega-fund manager that has to choose his/her shots carefully.
Below are the eight holdings acquired over the past 3 years and the rationale for each.
Procter & Gamble (PG) - The first stock selected, and a no-brainer from the perspective of all of my criteria. A lasting business model, top brand, strong management bench, and a healthy dividend all make this about as safe (and boring) as they come.
Child's Lesson: Brand matters. P&G is everywhere you look and usually selling for a higher price than substitute goods.
Google (GOOG) - Stock #2, selected in early 2008 and admittedly the disappointment of the bunch. Although the stock hasn't appreciated, the company continues to grow in revenues and significance in our daily lives. Google's "darling" phase may be over (or it may not), but it will continue to be a powerhouse of the online & mobile space, and I see no scenario in which digital technology becomes less important to us. Leadership may not be the most shareholder friendly, but I'm comfortable with this one for 5 years or longer.
Child's Lesson: Innovation matters. Technology occasionally come along and change the ways we live our lives. These innovations produce great wealth.
Bonus Lesson: The internet is not free. A lot of money is being paid to win your attention.
Disney (DIS) - This was primarily pandering to little girls' universal love of anything involving princesses. But it's also a very solid company with valuable & diverse assets. The slight dividend isn't much, but solid balance sheet makes me feel extra comfortable for the long term.
Child's Lesson: Corporations are responsible for many of the wonderful things in our lives (they are not evil). Delight your customers and the money will follow.
Yum Brands (YUM) - This has been the big winner of the bunch (and credit goes to grandpa for this one). Exposure to a market like China can fuel lots of growth and growth expectations. This is one of two positions I've taken partial profits in, but still a long-term hold.
Child's Lesson: Emerging markets are untapped sources of growth. And kids in some places of the world have never had Pizza Hut, so don't feel sorry for yourself if your parents only take you there a couple of times a year.
ExxonMobil (XOM) - As the world's largest company, Exxon seemed to earn a place at the table. Oil / energy is a major part of our economy and likely to be with us much longer than the investment horizon I'm considering. I gave some thought to whether "big oil" was evil, but it's a part of the world we live in. Ignoring that doesn't help anything.
Child's Lesson: Size matters.
Silver ETF (SLV) - Maybe this one was a quick buck more than any of the others, but commodities like silver are highly valued in our world because they are scarce. This is the other that I've taken (partial) profits in. Seems like a little too much froth.
Child's Lesson: Perceptions matter. Things are sometimes worth whatever others will pay for them, intrinsic value is a very abstract concept. Beware the bubble.
Toyota (TM) - A fairly recent purchase (late summer 2010). I was first attracted to TM in the wake of the recalls earlier this year by a news story that Toyota executives had voted themselves a pay decrease because their profits had been lackluster. If GM execs had done that, they'd be paying the company to work there! Toyota makes high quality products in a very efficient manner, and began to innovate in alternative technologies (hybrid, etc...) before it was chic to do so.
Child's Lesson: Quality matters. You earn a reputation for quality over the long term. When you make mistakes, take ownership of them and try even harder to earn your customers' trust.
Verizon (VZ) - The most recent of the bunch, and being honest, a bit of a market timing play. It is clear that mobile and data will continue to be increasing parts of our worlds, and the fact that average citizens are paying $1000+ per year for that smartphone in their pocket is a clear indication of how much economic value they create. Verizon will eventually get the iPhone, and that'll be a huge boost, and Sprint (S) and AT&T (T) each have their own issues to deal with.
Child's Lesson: Watch the world around you. When adults (or kids) can't live without their Blackberry (or Nintendo DS), that's some good investment research.
And in case you're wondering, the fund has had above-market returns and below market volatility over each of the 3 years (out-performance of 6.6% per year). Perhaps everything we need to know we really did learn in kindergarten.
I plan to add two more holdings in 2011. Any ideas that would fit the bill? Retailer? Bank? Rail company? Healthcare? Also, anyone who's had more experience than me at explaining stocks to children, what was your experience?
Disclosure: I am long XOM, DIS, VZ, GOOG, SLV, TM.