Part Three: Investing Strategies 101
This is the third article in Crayon’s mini-series on investing for your kids. In this series, we’ll explore how it could work for your family and give you a few tips from our experts to make it easy, actionable and effective.
By now, you’re probably quite excited about the opportunities investing in shares could open up for your child, and you’re primed on how to be a good investor. The next step is to choose your approach.
While you can buy and sell shares at any time, they are a long-term investment because the share market is volatile in the short term but has trended upwards over the long run. So ideally, this is an investment your child will access at least five years from now, if not a lot longer.
In this article, we go through the three main ways you can invest in shares, and we evaluate each strategy based on:
Effort: the amount of time and knowledge required from you to do this well
Fees: the amount you’ll pay in direct costs
Values: how confident you can be that your investments align with your moral values and help build the future you want your child to live in
Minimum investment: the amount you need to get started
Access: how easily you can withdraw the money
Diversification: how easily you can achieve diversification
Real-world examples: we’ve named New Zealand examples, so you have a reference point. These are not recommendations from Crayon.
The strategies are listed in no particular order. It may seem like a lot to absorb, but making a good decision upfront will reduce the stress that can arise from having picked a less suitable strategy - and set your child up for success.
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Diversification is about not having all your eggs in one basket. Owning a variety of shares is less risky than owning only one stock because any business can have a bad run. However, the returns you’ll earn from a diversified portfolio tend to be lower than what you could earn if you happened to pick a single winning stock.
To have a diversified portfolio, a good rule of thumb is to own at least 25 different companies across a range of industries and countries (Motley Fool).
Strategy 1: Stock picking
You decide which individual companies you want to own and when to buy and sell them. This option is most appropriate if you want to be very hands-on with your child’s investment.
High effort. You need to do your homework, which could mean hours of your time finding potential investment opportunities, conducting analyses and monitoring your portfolio regularly.
Low fees - if you hold your investments for a long time. High fees - if you frequently buy and sell stocks. Since you’re investing for your child’s long-term future, you can keep fees low if you buy and hold.
Transaction fees: you pay fees every time you buy or sell stocks, which can add up if you trade often. There are commission fees that depend on how much you’re investing and additional foreign exchange fees if you’re investing overseas. At the low end of fees, you need the price to go up by around 5% to recover the cost of buying and selling shares.
Management fees: none. The two other approaches detailed below - actively and passively managed funds - involve someone else managing your money, for which you pay an ongoing fee. You don’t pay any ongoing fees for holding shares.
Other fees: none.
High values alignment. Since you’re picking the stocks, you can choose to avoid companies that don’t align with your values and/or invest in companies that promote your values.
Small starting amount. Many stock trading platforms now have minimums as low as one cent.
High access to your investment. You can sell some or all of your stocks on any business day and receive the funds within a couple of days.
Diversification is possible if you do the work. Thanks to fractionalisation (where you can own part of a share - helpful when stocks such as Alphabet, Google’s parent company, last traded at NZ$3,300+ a share), you can achieve diversification with a small amount of money. You still need to find at least 25 companies you want to invest in and ensure they’re across different industries and, ideally, countries as well. Alternatively, you could choose to have a concentrated portfolio with a handful of stocks - keep in mind that this is significantly riskier.
Real-world examples: as of 30 June 2022, the five largest NZ stocks are Meridian Energy, Fisher & Paykel Healthcare, Auckland International Airport, Spark New Zealand and Mercury NZ. Globally the five largest stocks are Apple, Saudi Arabian Oil Co., Microsoft, Alphabet and Amazon.
Strategy 2: Actively managed funds
An actively managed fund pools money from many investors and invests on their behalf. The performance of an actively managed fund is influenced by the team of investment professionals who manage the fund. They make two types of judgment calls:
They choose which stocks to hold and when to buy and sell them based on their research and opinions.
They have some discretion (within limits) in how much they invest in shares and how much they keep in cash. For example, if an active fund manager thinks the market will go down, they may keep more in cash.
This option is most appropriate if you want to outsource the work to someone else and you believe that the professional you’ve chosen can outperform the market for years to come.
Medium effort. While you don’t need to research individual companies, you still need to research various investment managers, select one(s) that you think will do well and monitor their performance over time. There are dozens of active funds in New Zealand that invest in stocks.
Medium to high fees.
Transaction fees: some (but not all) funds charge fees when you make and withdraw your investment, ranging from 0.05% to 0.50% of the transaction value.
Management fees: you’re paying for the investment manager’s expertise in the form of a percentage fee on the amount of money you have invested with them. The average fee for an actively managed fund is around 1.2% per year. This means over a 5-year period, your investment needs to go up by at least 6% for you to recoup the fees. Over 10 years, it needs to go up by almost 13% and over 20 years, almost 27%.
Other fees: some (but not all) actively managed funds charge an additional performance fee such that they take a cut of your profits above a threshold.
Medium values alignment. Since the fund manager selects the stocks, you don’t have any say in what they do or don’t invest in. However, there are a growing number of ethical investment funds, and Mindful Money can help you screen funds.
Starting amounts vary from fund to fund. On the low end, some funds allow you to invest a minimum of $50 per month with no transaction fees if you commit to a regular investment plan. On the high end, some funds require an initial investment of $10,000 or more. Platforms such as Sharesies can reduce the minimum investment into a fund to 1 cent, but you will pay transaction fees.
Medium access to your investment. Most funds allow you to cash out your investment on any business day, but this is worth checking as some funds only permit monthly withdrawals. Many funds have minimum withdrawal amounts, typically the lower of $1,000 or your investment balance.
Instant diversification. When you invest in an actively managed fund, you instantly gain exposure to all the stocks in that fund. That being said, actively managed funds can vary in their level of diversification because:
Every fund has a mandate, which is a set of rules governing how the money should be invested. The mandate can be broad (e.g., any stock in the world) or narrow (e.g., NZ property stocks only). The narrower the mandate, the less diversified your investment will be.
Two funds with a similar mandate may still offer different levels of diversification because of the investment decisions made by the fund manager. Mandates usually limit how much of the fund can be invested in a single company, but the manager has discretion within those limits.
Real-world examples: well-known active fund managers in New Zealand include Milford, Harbour, Mint, ANZ Investments and Salt.
Strategy 3: Passively managed funds
A passively managed fund also pools money from many investors and invests on their behalf. However, rather than having a team of professionals picking stocks, a passively managed fund aims to track a stock market index. This option is most appropriate if you want to follow the market’s performance.
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A stock market index is a collection of stocks that represents and measures the performance of a specific market. For example, the S&P 500 Index is made up of the 500 largest companies listed in the US.
When the index goes up, it means overall, the prices of the stocks in the index are going up. The opposite is occurring when index levels are falling. Indices provide real-time information about the health and sentiment of financial markets, which is why they’re often quoted in the news.
Actively managed funds try to do better than the index by holding some stocks in a higher concentration than the index and not holding some of the stocks in the index.
Passively managed funds try to track the index. Their goal is to match the index performance with as little deviation from the index as possible.
Low effort. You need to find a provider that offers investments in the index you want to track (e.g., NZX 50 tracks the 50 largest companies in NZ, S&P Global 100 tracks the 100 largest companies in the world).
Low fees.
Transaction fees: some (but not all) funds charge fees when you make and withdraw your investment, ranging from 0.05% to 0.50% of the transaction value.
Management fees: the fees are noticeably lower compared to actively managed funds since the investment manager’s job is to replicate the index instead of doing a lot of work trying to pick winners. The average management fee for a passively managed fund is around 0.5% per year and can be as low as 0.1%. Based on the average, over a 5-year period, your investment needs to go up by at least 2.6% for you to recoup the fees. Over 10 years, it needs to go up by 5.1% and over 20 years, more than 10.5%.
Other fees: none.
Low values alignment. By definition, investing in a passively managed fund means gaining exposure to all the stocks in the index it tracks. There are two ways to navigate this from a values perspective and both have their limitations:
Exclusionary: increasingly there are passively managed funds that take environmental, social, and governance criteria into account by excluding certain stocks such as weapons and tobacco. This isn’t perfect because the decision to exclude a company is typically only made if the company generates revenue from these activities above a certain threshold. This means you may still find some companies who produce armaments (amongst other business activities they conduct) in what should be a weapons-free index fund.
Thematic: these funds are focused on companies in a specific sector, such as clean energy, or that fulfil specific criteria, such as high gender diversity in the C-suite. Keep in mind that a company could rate well on one criterion but not others. For example, you could have an environmentally-friendly company with poor governance or a women-led team of a large polluter.
Starting amounts vary from fund to fund but tend to be lower than active funds. Minimum initial investment amounts vary from fund to fund. On the low end, some funds allow you to invest as little as 1 cent. On the higher end, some funds require an initial investment of $1,000 or more.
Medium to high access to your investment. Most funds allow you to cash out your investment on any business day but check before investing. Some funds have minimum withdrawal amounts, typically the lower of $1,000 or your investment balance.
Instant diversification. When you invest in a passively managed fund, you instantly gain exposure to all the stocks in that fund. The level of diversification depends on the index the fund is following. For example, an NZX 50 Index Fund will give you exposure to the 50 largest companies listed in New Zealand but not any exposure to stocks overseas.
Real-world examples: well-known passive fund managers in NZ include Simplicity, Smartshares, Kernel and Vanguard.
Get Ready!
When it comes to investing for your child, all three strategies have their merits and their detractors. The right strategy for you comes down to how much effort you’re willing to dedicate to this and whether or not you believe it’s possible to outperform the market in the long term consistently. Some parents choose to have a mix of investment strategies.
In Part Four of this series, we go through the tax and legal considerations for selecting an investment for your child. It may sound dull, but the last thing you want is for your child to pay more tax unnecessarily or to blow all the money on a frivolous purchase without your knowledge!
This is part of Crayon’s mini-series on investing in shares for your child:
Now for the important legal part: Investing involves risk. You aren’t guaranteed to make money and you might lose the money you start with. The information we provide is general and not regulated financial advice for the purposes of the Financial Markets Conduct Act 2013. Please seek independent legal, financial, tax or other advice in considering whether the content in this article is appropriate for your goals, situation or needs. The information in this article is current as at 27 October 2022.
Stephanie Pow
Founder and CEO, Crayon
