It is often said that the earlier you start investing, the more you have for retirement. This is because you have a longer time-span for compounding to take effect. A typical investment life-span is about 30 years, so for a portfolio that can provide 4% real returns (or 7% nominal returns) annually, $1 at the start of 30 years will become $3.24 at the end of 30 years. However, if you can pass down the portfolio intact to your children who can continue to invest for another 30 years, $1 will become $10.52 at the end of 60 years. If they too can pass down the portfolio to their children and grandchildren, the portfolio will continue to compound further.
Although you might have more than 1 child and you wish to split the inheritance evenly between your children, this portfolio may still provide more money for each generation that the preceding one. For example, assuming you have 2 children and each of them will have another 2 children, each child will receive $1.62 and each grandchild will receive $2.63 when the portfolio is passed down to them. While these figures may appear small, these are after accounting for inflation. In nominal terms, each grandchild will receive $14.49.
Before you get too excited, you have to note that this portfolio is meant to be passed down to your children, i.e. it is not meant to support your retirement. If you need to draw down the money for retirement, the portfolio that you can pass down to your children will correspondingly reduce and compound to a smaller value.
How do you build such a portfolio for future generations? Active investment strategies will probably not work. While you might be the best fundamental analyst or technical analyst and make a lot of money from them, how do you ensure that your children and grandchildren are equally good at it? Assuming that you can pass down your analytical skills, how do you teach the mental strength to be greedy when others are fearful and fearful when others are greedy? And this is already assuming that they too are financially inclined and willing to invest the time to pour through financial statements and/or technical charts. So, a portfolio based on active investment strategy will probably not last through the generations.
Among passive investment strategies, there are two -- dollar cost averaging (DCA) and portfolio rebalancing. DCA requires a constant amount of money to be invested at regular intervals in the portfolio. There are 2 issues with this strategy. Firstly, over time, the same amount of money will reduce in value due to inflation. At an inflation rate of 3%, $100 will reduce to $41.20 after 30 years and $16.97 after 60 years. So, progressively, you (and future generations) will need to increase the amount invested over time. To maintain a constant $100 investment at today's value, you (and future generations) will need to increase the amount to $243 after 30 years and $589 after 60 years. The second issue is that DCA is meant to be used to build up the portfolio to a terminal value before you start withdrawing money from it. However, if this portfolio is meant to be passed down to future generations, then there is actually no withdrawal. This means asking future generations to invest an increasing amount of money over time into a "black hole" that they cannot expect to touch in their life-time. This might be too much to ask of them. Although the portfolio could be invested in funds that provide dividends at regular intervals, what they put in in regular investments might be more than what they could get out from dividends. This strategy is probably not sustainable.
The other passive investment strategy -- portfolio rebalancing, requires no further investments to be made. You just need to monitor the asset allocation to ensure that it does not deviate too much from the original allocation. If it does, you just need to sell the assets that have risen in value and reinvest the proceeds into assets that have dropped (relatively) in value. You just need to do this once every quarter or 6 months. If the portfolio is invested in funds that pay dividends at regular intervals, you get an additional source of passive income as well. In essence, this strategy does not require future generations to make any investments, but pays them regularly for maintaining the portfolio with minimal efforts! They are then more likely to maintain the portfolio and pass it down to their children. Also, when they recognise the beauty of this strategy, they could decide to make further investments into the portfolio and enhance it for their children.
Although you might have more than 1 child and you wish to split the inheritance evenly between your children, this portfolio may still provide more money for each generation that the preceding one. For example, assuming you have 2 children and each of them will have another 2 children, each child will receive $1.62 and each grandchild will receive $2.63 when the portfolio is passed down to them. While these figures may appear small, these are after accounting for inflation. In nominal terms, each grandchild will receive $14.49.
Before you get too excited, you have to note that this portfolio is meant to be passed down to your children, i.e. it is not meant to support your retirement. If you need to draw down the money for retirement, the portfolio that you can pass down to your children will correspondingly reduce and compound to a smaller value.
How do you build such a portfolio for future generations? Active investment strategies will probably not work. While you might be the best fundamental analyst or technical analyst and make a lot of money from them, how do you ensure that your children and grandchildren are equally good at it? Assuming that you can pass down your analytical skills, how do you teach the mental strength to be greedy when others are fearful and fearful when others are greedy? And this is already assuming that they too are financially inclined and willing to invest the time to pour through financial statements and/or technical charts. So, a portfolio based on active investment strategy will probably not last through the generations.
Among passive investment strategies, there are two -- dollar cost averaging (DCA) and portfolio rebalancing. DCA requires a constant amount of money to be invested at regular intervals in the portfolio. There are 2 issues with this strategy. Firstly, over time, the same amount of money will reduce in value due to inflation. At an inflation rate of 3%, $100 will reduce to $41.20 after 30 years and $16.97 after 60 years. So, progressively, you (and future generations) will need to increase the amount invested over time. To maintain a constant $100 investment at today's value, you (and future generations) will need to increase the amount to $243 after 30 years and $589 after 60 years. The second issue is that DCA is meant to be used to build up the portfolio to a terminal value before you start withdrawing money from it. However, if this portfolio is meant to be passed down to future generations, then there is actually no withdrawal. This means asking future generations to invest an increasing amount of money over time into a "black hole" that they cannot expect to touch in their life-time. This might be too much to ask of them. Although the portfolio could be invested in funds that provide dividends at regular intervals, what they put in in regular investments might be more than what they could get out from dividends. This strategy is probably not sustainable.
The other passive investment strategy -- portfolio rebalancing, requires no further investments to be made. You just need to monitor the asset allocation to ensure that it does not deviate too much from the original allocation. If it does, you just need to sell the assets that have risen in value and reinvest the proceeds into assets that have dropped (relatively) in value. You just need to do this once every quarter or 6 months. If the portfolio is invested in funds that pay dividends at regular intervals, you get an additional source of passive income as well. In essence, this strategy does not require future generations to make any investments, but pays them regularly for maintaining the portfolio with minimal efforts! They are then more likely to maintain the portfolio and pass it down to their children. Also, when they recognise the beauty of this strategy, they could decide to make further investments into the portfolio and enhance it for their children.
There is still 1 other factor to consider, which is the ability of future generations to make prudent financial decisions. Some of the descendants might be investment experts while others might just squander it away. The vast majority are likely not financially inclined. My current thinking is to split the inheritance so that each has its own portfolio to manage. If one of them were to squander his own portfolio away, there is nothing much we can do, but at least it does not affect the portfolios of others in his generation. For the vast majority who are not financially inclined, the above strategy will work well for them, as it does not require an investment expert to maintain the portfolio. And for the investment experts in future generations, they will be able to grow their portfolios without any help.
There is a saying that if you give a man a fish, you feed him for a day. But if you teach a man to fish, you feed him for a lifetime. We always strive to earn more and invest prudently so as to leave as much assets as possible for our children so that they can live a better life than us. Yet, are the assets that we pass down to them fish that last a couple of years or fishing instructions that they can benefit for life? Ironically, fish costs money to build up but fishing instructions cost almost nothing but are worth a lot more!
Lastly, please also pass down an instruction to help those in need when your future generations become rich, for their fathers/ grandfathers/ etc. (i.e. us and our fathers), were once poor before.
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Once the investment portfolio reach large size and convert it to trust fund or foundation and employ money manager?
ReplyDeleteYes, this is a possible option too.
DeleteThanks for the view on super-long term investment strategy that span across generations.
ReplyDeletewhat kind of portfolio do u suggest?
ReplyDeleteYou may wish to refer to http://boringinvestor.blogspot.sg/2014/02/the-passive-portfolio.html for some ideas in setting up such a portfolio. You will need to adjust according to your needs and risk preference.
DeleteIn theory, works. In practice, impossible.
ReplyDeleteeasy to say, hard to do.
Agree that it will be difficult. But if we don't try, we won't stand any chance.
DeleteLet do a reverse. Do you like your father to follow the same instruction from your parent as parent know what is best for you when you are 20, 30, 50?
ReplyDeleteThanks for your comments. The instructions are not mandatory for future generations. They are a means for future generations to learn how to invest.
Delete