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1 Talking to Children about Investing – https://fa.morganstanley.com/fishbein Ronald L. Fishbein Senior Investment Management Consultant Managing Director – Wealth Management Financial Advisor
Talking to Children about Investing
Ronald L Fishbein Senior Investment Management Consultant Managing Director – Wealth Management Financial Advisor [email protected]
This paper does not discuss talking to children about family wealth. That topic is covered very
well in a Morgan Stanley Whitepaper (2013) written by Glenn Kurlander entitled “Opening Pandora’s
Box”. The Kurlander paper may be accessed at the Fishbein Group’s website at
https://fa.morganstanley.com/fishbein. In his paper, Kurlander discussed the “responsibilities,
obligations and challenges that come with wealth.” It is a paper about how to talk to children about
how a family values money and what they hope to accomplish with their money.
This paper is much more specific than one that discusses the broader topic of family values
concerning money. It is about how you encourage children, younger than high school age, to develop
the habit of lifetime investing. As many adult investors are aware, the younger one starts to invest, the
longer the money has to compound. At a 7% compounded rate of return, a portfolio will double in
roughly ten years. Therefore, over a lifetime, the investor who starts investing ten years sooner than
the typical investor will have double the amount of money than if they had started investing ten years
2 Talking to Children about Investing – https://fa.morganstanley.com/fishbein Ronald L. Fishbein Senior Investment Management Consultant Managing Director – Wealth Management Financial Advisor
later. Over a lifetime of investing, doubling your money one more time than is typical can make a
difference of millions of dollars.
A Walk with my Grandson
Recently, my wife and I were visiting our daughter and family who live in another state. One
evening, my nine-year-old grandson Dean and I were taking a stroll around the neighborhood. During
our walk, Dean started talking to me about how he was considering using some of his “savings account”
money to buy a new bike. He already had a perfectly good bike that had many gears, but, according to
Dean, this new potential bike was far superior. When I was Dean’s age, my bike had three gears and it
worked quite well. Obviously, from an adult’s perspective, Dean’s potential purchase of a new bike,
when his existing bike was not very old, was not the best use of his money.
Dean and I had talked about financial topics before and he understood some very basic
concepts. Dean likely knows more about finance and investing than most children his age because his
parents both work in the field. That is, his mother is a Financial Advisor with Morgan Stanley and his
father is a finance professor. However, the concepts that we discussed should be comprehendible by
most bright children his age. The important outcome of our conversation was that by the time we were
finished, Dean wanted to invest his money in a mutual fund rather than buy a new bike.
How Do You Go From a New Bike to a Mutual Fund?
The following quote is often attributed to Albert Einstein: “Compound interest is the eighth
wonder of the world. He who understands it, earns it…he who doesn’t…pays it.” Once someone
understands how compound interest works, whether they are a child or an adult, they will understand
that it is like magic; that is, you are making money on the money that you have already earned. If a
3 Talking to Children about Investing – https://fa.morganstanley.com/fishbein Ronald L. Fishbein Senior Investment Management Consultant Managing Director – Wealth Management Financial Advisor
child’s math skills are advanced enough to understand how percentages work, they should be able to
understand the theory of compound interest. In Dean’s case, we discussed investing $1,000 and
consistently making 10% per year, the approximate long-term return of the U.S. stock market and a
round number for illustrative purposes1.
After we had discussed and Dean had mastered the idea of compound interest, we discussed
the little wrinkle that one’s investments do not make the same return every year, but what is important
is the average compounded return over many years. As part of that discussion, one can explain the
concept of market volatility and that the rate of return over a five year period is often very different
than the return made over twenty to thirty years.
The next step in our discussion was about how one invests $1,000 and obtains a respectable
compounded rate of return over many years. This lead to a discussion of the concept of diversification
although the word “diversification” was never used in the conversation. We discussed the idea of
diversification in terms of analogies such as eggs in baskets, one at bat compared to a baseball season’s
batting average, talking to one voter compared to talking to hundreds of voters, etc. Since Dean already
understood the notion of owning a stock, he naturally asked, “How many stocks can we buy for
$1,000?” The answer, of course, was not many.
The next part of our conversation was a discussion of the concept of a mutual fund. For many of
us who have been investing for many years, a mutual fund may seem very mundane, and when 1 The Geometric Average Return for the Standard &Poors 500 Index, 1928-2013, was 9.55%. See New York University Stern School of Business Website, http://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/histretSP.html, 1/5/2014 update, by Damodaran, Aswath.
4 Talking to Children about Investing – https://fa.morganstanley.com/fishbein Ronald L. Fishbein Senior Investment Management Consultant Managing Director – Wealth Management Financial Advisor
compared to portfolios that contain many mutual funds and separately managed accounts with tax
management and automatic rebalancing, a single mutual fund seems very outdated. However, I
remember the first time I learned about mutual funds, and thinking that it was an amazing concept.
Certainly, back in the 1960’s, the ability to pool your money with other investors such that you owned a
diversified portfolio that was managed by full-time professionals and you paid about a 1-2%
management fee was quite cutting edge. Nevertheless, even for a bright and technology-savvy nine-
year-old, the benefits of a mutual fund, when heard for the first time, still seemed rather amazing.
One of the advantages of investing in a mutual fund that has been in existence for many years is
that the annual report will often show the returns for rolling time periods such as ten, fifteen, twenty, or
even thirty year periods. In viewing such a report, it is very informative to see that over long time
periods, in many cases, the returns are not very different from one rolling period to another. These
charts are illustrative of the lesson that over long periods of time, in most cases, the good and poor
periods in the market seem to counteract each other and a reasonable return is provided.
The lesson for any investor is that the key to success in investing in equities is that, at least
historically, long-term investors do very well. Needless to say, the information in the annual report that
showed returns for rolling time periods helped convince Dean that investing in a mutual fund for a long
time period was an excellent way to make his $1,000 significantly increase in value.
Conclusions
Many children who are still in elementary school are old enough to understand basic investment
concepts. Usually, the sooner they are introduced to these basic principles such as compounding and
diversification, the better. Often, an excellent way for a child to start investing a small amount of money
5 Talking to Children about Investing – https://fa.morganstanley.com/fishbein Ronald L. Fishbein Senior Investment Management Consultant Managing Director – Wealth Management Financial Advisor
is with a mutual fund that has been in existence for many years where the annual report contains a
trove of historical information. If investments already exist for a child such as a college savings account
that may have been started soon after birth, we recommend that the child be shown some of the
investments and a discussion ensue about the benefits of the investment plan. Whether the investment
discussion is about a potential or existing investment, we recommend that the child should periodically
be shown an account statement or a mutual fund report to further their understanding of the
investment process. Account statements can be particularly enlightening when periodic investment
contributions have been made.
Morgan Stanley Smith Barney LLC (“Morgan Stanley”), its affiliates and Morgan Stanley Financial Advisors or Private Wealth Advisors do not provide tax or legal advice. Clients should consult their tax advisor for matters involving taxation and tax planning and their attorney for matters involving trust and estate planning and other legal matters.
The views expressed herein are those of the author and do not necessarily reflect the views of Morgan Stanley Wealth Management or its affiliates. All opinions are subject to change without notice. Neither the information provided nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. Past performance is no guarantee of future results.
We are not recommending or advising the use of mutual funds or any particular investment product. Consult your financial advisor for investment advice and information on products that are suitable for your situation.
The appropriateness of a particular investment or strategy will depend on an investor’s individual circumstances and objectives.
Investors should carefully consider the investment objectives and risks as well as charges and expenses of a mutual fund before investing. To obtain a prospectus, contact your Financial Advisor or visit the fund company’s website. The prospectus contains this and other important information about the mutual fund. Read the prospectus carefully before investing.
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