Investment diary of a CIO’s son

My youngest son is starting out on his investment journey. As background, he has been gifted some money, which he wants to invest for at least 7-10 years. He is not interested in finance, although he is interested in making money. He is about to go to university in February and expects to be busy. Therefore, he wants to have an investment plan which he does not have to monitor excessively. He is obviously worried about investing at exactly the wrong time, as is common with most investors, especially those who are first timers.

The starting point for our conversation was to highlight how volatile equity markets are. We looked at a lot of charts to get a sense of the size of drawdowns seen over different periods of history. Clearly, the bursting of the dot.com bubble, the 2007-9 Global Financial Crisis and the Covid experience jump out on the charts. I overlay all this with my view that these were very severe in nature and ‘normal’ recessions are usually less severe. However, I made it clear that no one knows with certainty what is going to happen.

We talked about the fact that bonds usually rise in value when equities weaken significantly, thus dampening the volatility of a diversified portfolio consisting of stocks, bonds and alternative assets, but also discuss the 2022 experience when both stocks and bonds fell at the same time due to concerns about rising inflation. This led us to discuss gold which can help protect against inflation over the long term – in 2022, gold was flat on the year, although it experienced a significant decline (22%) during the year.

Allocating the money

After going through this process, we discuss what his target allocation for equities, bonds and gold should be in two years’ time. He decides on 75% to equities, 15-20% to bonds and 5-10% to gold. The reasoning is that his time horizon is relatively far away and may even be extended further. Meanwhile, he will not be looking at the portfolio on a daily or weekly basis. Therefore, he believes he will not ‘feel’ the volatility as severely and won’t be overly emotional even if he sees his portfolio down by 40-50%, which is the maximum drawdown seen for this type of allocation since 2000.

Then, we discuss the path to get to that target allocation. He is keen to get started. So, he decides to invest about 50% of his total investment pool for a start: 30% in equities, 10% in bonds and 5% in gold. Bonds have sold off a bit recently, so he is looking to take advantage of locking in the higher yields. Meanwhile, he is a little concerned about how expensive equity markets are, so he is going a little slower here relative to his target allocation. Thereafter, he will gradually add to the portfolio and accelerate investments if any of the asset classes go on sale.

So far so good. Getting to this point has been relatively painless and he understands that if he makes a mistake, he is still very early in his journey and he can learn and recalibrate along the way.

Constructing a portfolio

Now the practical question is: How does he go about investing his money? While he has a brokerage account, he already understands that he does not want to pick stocks (at least for now) - he has been around me enough to understand the benefits of a diversified portfolio. We discuss the various approaches to creating a diversified portfolio, including active management (through mutual funds) and passive investing (through exchange-traded funds, or ETFs). He decides on a blended approach.

We start with the S&P 500 index, the benchmark for US equities, which now has a 32% allocation to technology sector equities. A young investor is almost always comfortable with this idea of ‘technology is the future’. However, after a quick conversation about how expensive this sector is, he decides that having some exposure makes sense, but he wants to mitigate this risk by including an exposure to the S&P equal-weighted index and non-US markets, such as the UK, Europe and Asia. The latter significantly helps diversification. Eventually, he suggests that of the 30% of funds he is going to allocate to equities, he wants to invest 15% into the US (10% in the S&P 500 index and 5% in the S&P 500 equal-weighted index) and 5% each into Europe, the UK and Asia.

For bonds, after a discussion of the different areas of the bond market, he chooses a globally diversified bond fund which has a high weight to investment grade bonds, thus maximising the diversification benefits to the overall portfolio. An allocation to a gold ETF just adds to the diversification within the portfolio.

Making a start

While the portfolio put together may not be theoretically optimised, we decide it is good enough for somebody starting out on their journey and can be refined in the future, in need.

The key thing for me was, despite being an 18-year-old, he made all the decisions. It is important that he takes accountability for his financial future. If he were to lose all this money, it would not be financially material to him in the coming 5-10 years. However, this diversified approach should ensure that this does not happen and that, at the very least, he will learn a lot about himself and his attitude to risk. In my opinion, this exercise is priceless. At this age, in particular, the journey is more important than the destination.