Teaching your kids about the stock market: part two
In my previous post I talked about the importance of giving kids a grounding in basic financial concepts to help them plan for the future effectively.
Sharesight clients would agree that investing in the share market can be both financially rewarding and personally satisfying, and I know that many of us are keen to get our children involved in some way.
So, what do we need to teach young people about share market investing once we’ve helped them get a basic understanding of financial concepts?
Here are my top share market basics that any investor needs to understand before they get started.
1. Only invest what you won’t need to liquidate
I’ve said it before, but I’ll say it again. Unless you’re a professional trader, share investing is a long-term business. Over a period of many years, the share market will generally outperform other investments. But if you need to withdraw your money at short notice, you run the risk of having to sell when markets are low, which could cause you some serious losses.
2. Be prepared to ride the ups and downs
Short-term market turbulence can be disconcerting and many investors at the moment are nervous about their on-paper losses. However, numerous studies have shown that share markets do better over the long term, so sticking with it will usually be a better option. Nonetheless, if you’re not prepared to ride out the lows for the sake of longer term gains, then stock market investing probably isn’t right for you.
Diversification is important for two reasons: it can potentially protect you against undue losses if investments in a particular company, sector or asset class fail, and it can actually improve the overall return of your portfolio.
To get your kids thinking about diversification, help them buy a small portfolio of 3-5 shares in different industries. The share market makes diversification easy because almost every industry is well represented. Don’t overdo the diversification though. It does not guarantee success and if it’s overdone it adds complexity and it can dilute returns if it results in investment in lower yielding assets. See this article for more on diversification.
4. Do some easy homework
Start off buying into well-known companies that have been around for a long time. Look for companies that do things you understand and operate in areas that are likely to grow in future. Thinking about some basic questions will quickly highlight industries with good potential. What is the future of the Australian mining industry? What are the implications of our aging population? Will tourism remain a growth industry?
5. Keep an eye on performance
Share investing may be a long-term business, but that doesn’t mean you can take your eye off the ball. There may be times where you want to sell down some of your holdings, or reallocate some of your exposure to maintain diversity. Staying abreast of the performance of your shares is important, and you can do this by reading the financial press and specialist websites, and subscribing to a service that will give you an overall picture of your portfolio’s performance, such as Sharesight. But remember that you are in there for the long haul so resist the temptation to panic and sell if prices take a short term tumble. Make your decisions on what you believe are long term trends, not short term volatility.
6. Don’t fall prey to “shoebox syndrome”
As all share market investors know, the benefits of being in the market come with responsibilities to the tax office. If you’re not prepared to keep your paperwork in good order throughout the year, or use an online share portfolio management service such as Sharesight to do it for you, you most likely will end up in a last-minute scramble to get your affairs in order.
What other tips do you have for teaching your kids (or grandkids) about the share market?