Compounding Collaboration, Month #6
Every month I put aside some money into a portfolio aimed at long-term bets over the next 20 years. I will be gifting this portfolio to my future kids someday- in the hopes of using it as an educational tool alongside the memos I write to teach them about the world and to have a shared activity to work on together as they grow up.

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Here is the performance so far from the first five months:

‌‌Month #1, August 2020: $ARKK +57%
Month #2 September 2020: $ARKG +58%
Month #3 October 2020: $BTC.X +156%
Month #4 November, 2020: $BTC.X +65%
Month #5 December, 2020: $NVDA -1%

One of the main purposes of this portfolio is to use the different holdings as conversation pieces to teach my future kids about the world.

While talking to Justin Gage (@itunpredictable) this week I realized I'm missing a holding that I will likely want to make conversation #1 with a kid who is just beginning to learn about investing and the markets.

And that is company-specific risk.

I like this portfolio because it forces me to look at the world with the eyes of a kid who literally knows nothing. When you don't know anything- everything is a much bigger risk.

And one of the biggest unnecessary risks is company-specific risk, which just refers to any risk that a particular company could face, from increased regulation, more competition, to just plain old bad luck, like a storm that disrupts your supply chain, or the brilliant CEO gets really sick and has to step down.

A lot of company specific risk is unpredictable. And by definition, it is just a risk to the one company you're looking at.

But there is a way to mitigate company-specific risk, and that is to invest in multiple companies. That way, if something bad happens to one company, it is not detrimental to your portfolio, because the other companies weren't negatively affected by that same risk factor.

This is an argument for diversification- the idea that you should put money in many companies, so that no one company's downfall can make that much of a difference to your overall wealth.

The flip-side though is that no single company performing extremely well will move the needle much for you either.

While I tend to think that there is a healthy balance to be found (a portfolio of say 20 stocks is a good amount of diversification, 100 limits your upside, 2 exposes you to too much risk), there is a lot of research that has been done that points toward the fact that any outperformance in excess of the broader market performance is due to luck rather than skill. (87% of all US fund managers underperformed the broad S&P Composite 1500 Index since 2005.)

While I personally believe that expertise and research can allow you to outperform based on your efforts, I would still want to introduce the ideas of diversification and luck to my future kid, and let them think for themselves.

So that is why this month, my investment that will trigger this conversation is:
Vanguard Total World Stock ETF ($VT)

$VT is basically a tiny piece of every company in the world. You've totally diversified out any company specific risk. Your risk is the overall market risk.

I think for a kid, that's a really good way to get introduced to investing, in contrast to options, gambling, and trying to make a quick buck.
Gaurav Mishra's avatar
@nathanworden Is that combination of all indexes? How it would be different from a index based ETF?
Nathan Worden's avatar
$VT holds 8,849 different stocks, so yep, it's basically one big index that tracks the entire world market as best you can.

Yeah, I guess you can think of it as a combination of all indexes. And I might be misunderstanding your question, but I believe you would in fact call $VT an index based ETF.

From Vanguard's website:
The Vanguard Total World Stock ETF seeks to track the performance of the FTSE Global All Cap Index, which covers both well-established and still-developing markets.

Gaurav Mishra's avatar
I was confused by the name; it looked like a index stock. Thanks for clarifying.
Nick Mendola's avatar
If you want a real conversation starter with your future kids go with $MSOS. Cannabis ETF with heavy weight on the larger cap US multi-state cannabis operators (who are listed on Canadian Exchanges due to current US federal legislation can not list in the US. Great podcast with the PM of the ETF here. He explains the huge upside potential of the US MSOs vs the Canadian operators such as Canopy (who are listed on US exchanges). By the time you have kids old enough to understand, cannabis will no longer be a Schedule I drug and likely legal in the majority of States. Cannabis industry will be enormous and those who invested early will be handsomely rewarded.

Nathan Worden's avatar
haha could be a great history lesson of how public sentiment and laws change over time. Regarding shifts in the cannabis landscape, I'm mostly interested in prison reforms. I'm always thinking about how certain shifts would be a net benefit to society, and while I'm not a cannabis user myself, I think legalization could be a step in the right direction towards having a more just society.

I'll check out the podcast!
Cool to read this Nathan!
Nathan Worden's avatar
Thanks for checking it out Nicole!
Nathan, is there a special account that you can create for your children? are there any tax advantages?
Nathan Worden's avatar
Fantastic question @navazz, I worte a memo pondering that exact question:

The TL;DR is:

529 Savings accounts can be good if your main purpose is to save for education, BUT if your kid doesn't end up incurring a "qualified higher education expense", not only will you lose the tax advantages, you will also get penalized 10% of all that money you saved.

A Coverdell ESA is another option. It's a self-directed tax advantaged savings account for educational expenses too, but has some different details, like having a max of $2,000 per year.

You could also do a trust, and put your kids name down as a beneficiary.

In general, this is a question I want to look further into myself. I am thinking really far ahead, because my kids aren't even born yet. But I'm sure I will want to consult a tax professional soon, because the tax implications for long term savings are pretty enormous.