How My 7- And 11-Year-Old Kids Built World-Class ETF Portfolios

|
Includes: ACWI, CRBN, DRW, FNDE, INTF, JHMT, KNOW, SCHC, SPEM, SPTM, SPVU
by: Tariq Dennison
Summary

Although I have long encouraged my kids to own a few good individual stocks they can understand, I appreciate their interest in top down ETFs holding thousands of stocks.

This article explains how I helped my 7 year old and 11 year old create well-balanced ETF portfolios, while allowing them to choose the screening criteria.

My 11 year old chose a portfolio with a strong value tilt.

My 7 year old, on the other hand, chose ETFs that were broader, more passive, and with lower expense ratios.

I expect them to learn as much by following these ETFs as they have their single stocks.

One night last week, I was pleasantly surprised when my kids asked if they could stay up late and buy some ETFs with me. We ended up staying up over an hour past their bedtime running through the ETF screeners, reading factsheet pages, and submitting orders, and I admit it has been one of my proudest moments so far to see them so driven and interested in getting the orders filled and seeing the shares in their accounts.

Some background: 10 First Stocks to Buy a 10 Year Old

I am a deep believer in financial education, and have tried my best to encourage my kids from an early age to be curious about the businesses around them, how those businesses make money, and how they can make money investing in them. We started buying shares for my older son on his first birthday though a DRIP plan, and later set up UTMA accounts at Schwab for him and his younger brother, as well as gifting and receiving shares for them through the more gift-oriented app Stockpile. Following my own recommendations in my earlier article “10 First Stocks to Buy a 10 year old”, my older son’s largest single stock position is in The Coca-Cola Company (KO) while my younger son’s is in PepsiCo Inc (PEP), and I have regularly provided them bite-sized doses of financial facts on their holdings. So far, both of them seem mostly focused on the dividends.

Why I haven't let my kids buy Apple yet

For months, both of them have been telling me they also want to own shares in Apple Inc (AAPL), to which I have repeatedly replied like any financially overprotective parent with “as soon as you can explain to me why and how you expect Apple to give you back twice as much money as you put into it, I’ll help you get some shares”. Of course, I hold the 7 year to a different standard than I would hold the 11 year old on this challenge, but neither have convinced me they understand the financials of Apple (rather than just the brand name and dividend history) enough to take the next step. Another hurdle they have in convincing me to add this specific name in their portfolios is that they already own Alphabet Inc (GOOG) and Alibaba (BABA) respectively, so would need to justify either why Apple would do better, or is worth doubling down on technology exposure for. I of course also want them to look at other sectors like financials or utilities, as I mention in my article.

My 11 year old discovers ACWI, then tells his brother

Two months ago, my 11 year old heard about the iShares MSCI All-countries World Index ETF (ACWI) by chance, and became fascinated with the idea that he could own an “all countries world index” of over 1,000 stocks within just a few shares of an ETF that he might even be able to trade at no cost. It was this discovery of ACWI that got him curious about how I build top-down ETF portfolios, and got him to convince his brother to get me to help them buy some ETFs that night.

How We Ran Our ETF Screens

The main drivers of choosing ETFs for this portion of my kids’ portfolios are the ability to invest small amounts with almost no trading costs, and to give them meaningful benchmarks to help them view and understand markets from the top down. Eventually, I expect they will sell lots of these ETFs to buy lots of single stocks as and when they are ready, but I am proud of their interest in running through this portfolio construction step with me.

Our ETF portfolio construction process was as follows:

  1. Only ETFs that trade commission-free within their Schwab UTMA accounts would be considered, of which there are now just over 500.
  2. Each child would chose their own screening and sorting criteria for the list of ETFs they want to run down, with the goal of choosing 5 ETFs each.
  3. Going down the list, I would then guide them by helping them read the ETF factsheet pages and understand the most important highlights of each ETF on the list: holdings, overlaps with other ETFs, risk/return profile, and how high or low the overall cost is to similar funds.
  4. I especially wanted to guide them to balancing US, non-US developed, and emerging market exposure, preferably with some diversification across issues and some factor exposure.
  5. Ultimately, each child had the final decision on which 5 ETFs they chose.
  6. Portfolios would be equally weighted among their 5 ETFs.
  7. I would log in and execute, letting them watch me. This helped them revise what I showed them earlier about bid, ask, limit order and market order prices.

My 11-Year-Old’s ETF Portfolio: Value Tilt

My 11-year-old chose to sort the list of commission-free ETFs by price/earnings ratio (P/E) from lowest to highest, with the goal of buying the most corporate earnings with the least amount of money. He has just started learning the difference between earnings yield and dividend yield, especially as I re-read the book "The Essential P/E", showing him some of the tables. Topping the screen were ETFs focused on Russia and Korea, which he didn't want to narrow on within his top 5, so he ended up choosing:

  1. WisdomTree Global Ex-US Real Estate ETF (DRW), which is topped by several Hong Kong property names he knows, and pays a 4% dividend yield,
  2. Schwab Fundamental Emerging Markets ETF (FNDE), providing his exposure to major emerging markets (including China), using RAFI fundamental factors at an expense ratio of 39bps,
  3. iShares Edge MSCI Multi-factor International ETF (INTF), covering Europe and Japan,
  4. Invesco S&P 500 Enhanced Value Portfolio (SPVU), one of the few S&P 500-based ETFs I like, because it narrows on the cheapest 100 quintile of the index, unlike other value ETFs, which I argue are too shallow, and
  5. Direxion All-Cap Insider Sentiment ETF (KNOW), which he liked just for the ticker, and had to have once I described how insider buying works as a factor.

Having spent more time following what I do professionally, it is perhaps no surprise he came up with a portfolio similar to the value-tilted ones I tend to build.

My 7-Year-Old’s ETF Portfolio: Broad, Passive and Inexpensive

My 7-year-old had a simpler approach, and I always appreciate the perspective of someone uncontaminated by all the research I read. Rather than value, he wanted to sort by which ETFs held the largest number of stocks, from highest to lowest, with the goal of owning a little bit of as many companies as possible. Many of the ETFs with the highest numbers of holdings are bond ETFs, and we decided to stick just to stocks for this exercise. Here are the 5 he came up with, going down that list with my help to cover all the bases:

  1. SPDR Portfolio Total Market ETF (SPTM) - He was drawn to this one by my explanation of the name "Spyder", and that it was a "total market" ETF. Even though I explained this only held every stock in the US, with a 3bp expense ratio, this was an easy one to add to the cart,
  2. SPDR Portfolio Emerging Markets ETF (SPEM) - This gives him exposure to over 1,000 stocks across Greater China, India, Brazil, South Africa, Russia, and even the UK, for the relatively low ER of only 11bp. He also liked the term BRIC, though understood the big EM ETFs are over 40% China these days,
  3. Schwab International Small-Cap Equity ETF (SCHC) - Covering Europe and Japan, though with a tilt towards smaller and more numerous companies.
  4. iShares MSCI ACWI Low Carbon Target ETF (CRBN) - Although this overlaps with the first three ETFs, he absolutely wanted an ACWI product, and seemed to like the low carbon factor as I described it, and finally
  5. John Hancock Multifactor Technology ETF (JHMT) - He admitted upfront he liked this because he still wants to own as much Apple as he can with no trading cost, and this one has over 5% weighting each in Apple Inc (AAPL), Microsoft (MSFT), and Facebook (FB).

Other than the last sector ETF, this portfolio looks far more like a classic market cap weighted global stock portfolio, perhaps not too different than ACWI itself.

What’s Next

While we had discussed using these ETFs purely as a placeholder until they were ready to choose their next individual stocks, I wouldn't be too disappointed if they held these ETFs longer term. I remain very critical of the S&P 500 index and funds that track the S&P 500, and feel that even if they are too busy with school work to read up on individual companies, these ETFs will at least interest them in factors and themes away from the S&P 500. If you reach out to me and remind me a few years from now, I'll be happy to update you on how these portfolios did.

Disclosure: I am/we are long SPTM, SPEM, SCHC, CRBN, JHMH, KNOW, SPVU, INTF, FNDE, DRW, KO, PEP, GOOG, BABA. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.