Okay, so I don’t have grandchildren yet, but I want to increase the odds you read beyond the title if you are old enough to have grandchildren. Should the investment advice we give to someone young truly be different from that given to someone old? And given where asset prices are, is it responsible to tell anyone to pile into the markets? Here are my thoughts on the topic, hopefully applicable not just for my children:

Hedge fund manager Ray Dalio likes to say he chose the first stock he ever bought because it cost less than $5 a share, given that his savings from caddying at the time were, well, five bucks. That story is a great icebreaker but also highlights with what’s wrong with our industry: when we think about investing, we immediately think about the stock market. Let’s take a step back.

My oldest recently returned back to college having completed a summer job. Thanks to our “Golden College Fund” (our kids’ college savings is in physical gold; please see this 2014 Forbes article for details), our son in the fortunate position that he doesn’t have to pay off college debt with his earnings. If he did, paying off college debt – like any other debt – is a choice of whether one expects a higher rate of return with one’s investments (after tax) than if one were to pay off the debt. It’s also a choice of risk tolerance, as a debt-free person has much less to worry about. 

Talking about worrying: the advantage a college kid without debt over just about any other adult has is that he or she has no obligations, notably also no family to feed. I allege that financial stress is foremost a function of expenses, not income.  As we grow older, we start piling on obligations: it starts with the indispensable mobile phone plan, might include that monthly car payment and possibly a mortgage. And if one is providing for a family, that too will take a good chunk out of the household income statement. 

As such, for college students, life is comparatively simple. That said, it might be a worthy exercise for anyone in a more complex stage in their life to re-evaluate where they are. Most have “legacy” payments they make, but do you really still need that $80 a month cable TV subscription? Or, at the more expensive end of the spectrum, that vacation home that’s a money pit; should it be sold or possibly turned from an expense leader into a revenue center by making it available on Airbnb? 

Have you ever noticed that if you go to a financial adviser, they’ll only recommend what they are licensed to recommend; or what their custodian can keep on their books? When it comes to investing, the first question you should ask yourself is not where to open a brokerage account, but what it is that you want to achieve. The brokerage account may merely be the means of achieving your goal. 

Many say young investors can afford to invest more aggressively because they have more time to recover from market crashes; again, the emphasis is on stocks. I would like to phrase it differently: a young investor has a very high earnings potential relative to their current savings. Let’s say you make $50,000 coming out of college, with $5,000 in the bank. The way I like to look at it is that the $50,000 is a revenue stream you are getting from the investment you have made in yourself, one that’s likely to increase over time. It’s for that reason that you can be more aggressive with those $5,000. And that applies no matter what age you are: if you are an executive making hundreds of thousands, evaluate the odds of that income stream holding up, and put that into the context of your savings (which are hopefully higher at that stage in your life).

For a young person, it may be all but impossible to fill in a questionnaire about one’s target retirement age.  I gather it’s difficult even for many fifty-year-olds: sure, we all dream of retiring on the beach. But many of us – I include myself here – are not dreaming of retirement: we need to keep our brains active, and the last thing we want is to become couch potatoes. Relevant for any financial planning is that in the opinion of yours truly, income derived from one’s personal labor ought to be seen as a revenue stream just like any other, with probabilities assigned as to the future course of such revenue. 

If along the way, you have invested in a vacation home that you are now renting out; that is an income stream as well (net of expenses, taxes, etc.). 

If one reaches the point in one’s life where one no longer wants to or is no longer able to “have a job”, well, then that income stream is cut off. Although even there, with regard to financial planning, I would like to pose the question: how healthy are you? That is, could you go back to work if you wanted or needed to? In my opinion, one you don’t often hear from financial planners, one of the better pieces of retirement investment advices is to invest in your health. If you are healthy at age 65, you have the potential to keep that revenue stream going, even if you end up choosing not to. That, in turn, improves your risk tolerance. 

The beauty of one’s personal earnings power is that one can control it far better than an investment one buys with the push of a button. When you buy that hot internet company, you have no control over management (with some firms there aren’t even voting rights associated). My personal view is that the riskier an investment, the more involved you want to be. For example, to make money in frontier markets, don’t be surprised if you lose your shirt if you give someone else your money to manage; a more profitable strategy may be to roll up your sleeves and get a job working there? No, it’s not unrealistic, especially not if you are young. Isn’t it all about “experiences” for the young generation? Well, here’s your chance! 

Instead, your friendly financial planner will ask you about your risk/return profile. What the heck does that mean? We all know how much upside risk we can tolerate (an infinite amount?!), but who understands the abstract notion of downside risk? Investors start to appreciate these concepts as they gain experience; and “experience” means a series of setbacks, including possibly a job loss that gets one to re-evaluate those expectations of ever higher salaries.

The concept of risk goes far beyond the standard deviation of a return stream of a security. The risk any investor faces is that the net present value of their expected future cash flows falls below a comfort level, taking into account not all investments are liquid (either because they are difficult to sell or one doesn’t want to sell, such as possibly one’s home). Here, college kids have a lot in common with the wealthy: they can go several years without income. A good time to start one’s own business may well be when one is young, as one doesn’t have to worry about dependents. It is more stressful (the risk is higher) to start a business if one has to support a family at the same time. Entrepreneurs in their 30s and 40s might have more experience, reducing the anxiety level as their odds of success increase. Yet there are successful entrepreneurs that started only in their 50s or later; the kids are usually out of the house; and they have few other obligations, so they can go all in to focus on that business armed with decades of experience.

The biggest investment we possibly make is in our own training. Another life choice investment is that of who one shares one’s life with. I’m not suggesting ‘investors’ should marry for wealth, but marriage will have an impact on one’s financial stability. Independent of whether there are one or two breadwinners in a household, a frugal spouse will reduce financial stress; also, a broken marriage can put a serious dent into anyone’s financial planning. 

When we buy a gadget, many of us spend hours surveying the market until we are comfortable we are getting value for money. We should do the same with any investment. Just because we can buy something with the click of a button doesn’t mean we shouldn’t take our time before taking action. 

In my view, a hallmark of successful investors is that they understand the market they are in. For the very young entrepreneur, it might be that lemonade stand. When I was in college, I bought a washing machine that I rented out to my housemates in off campus housing (great return on investment!). In the stock market, this might be as simple as buying shares in the Coca-Cola Company because they think their drinks are a good cash cow (this isn’t investment advice). But what I have a problem with is to invest in something simply because “everyone else” says it’s a good investment, even if it’s something as “obvious” as tech stocks in the late nineties or real estate in 2005. 

Gradually shifting towards the markets, I do not think there’s a unique right approach. But what I think successful approaches have in common is that there’s a process. And the process is more than signing up with a robo-advisor. Don’t get me wrong: there is value in automated re-allocation, and we’ll see it transform the industry, but the first generation of rob-advisors still has some maturing to do. 

Whatever we invest in, once we make the investment, the temptation is to justify the investment even as the reasons for the initial investment has changed. A prime example is one’s primary residence. Many perceive their own home to be of great value, even if prices in the neighborhood have moved to ridiculous levels. Or take that stock you purchased; you don’t want to admit you made a mistake as the price moves against you. It gets back to process; it’s also usually best to recall why you purchased something in the first place; if those conditions are no longer met, do you make the data fit the story, i.e. are you merely justifying past decisions? That’s where starting with a clean slate is a great advantage. That said, any sixty-year old investor can go through the same exercise: if I didn’t own xyz, would I buy it today? Okay, do take into account that you might have to pay substantial taxes if you liquidated an investment, does xyz make sense in your asset allocation? If not, you may have put enough money aside so that you can afford to keep a pet project around, but at least be honest about it. 

Talking about pet projects: investing in venture capital is supposed to be about diversification, not about bragging rights. Just saying. While this jab is not aimed at the young investors, those of you it is aimed at might recognize it.

Lots of models show you that if you start investing early, it pays off big time, as compounding works in your favor. But that doesn’t mean you should invest in something stupid just for the sake of being invested. And looked at differently, back to the college graduate with $50,000 income / $5,000 in savings: in a world where the 10-year government bond trades at 2.162% (the yield as I write this), the $50,000 in income corresponds to a $2,312,673 bond (the annual payment from such bond is $50k). Looked at it from that perspective, your $5,000 in actual savings represents only 0.22% of your portfolio. It means, you will be all right if your first investment doesn’t pay off. It is okay to learn (read: make mistakes). But it’s also okay to be on the sidelines. The advantage of having your capital at risk, however, is that you are more likely to take an interest, that is, being in the trenches provides experience and perspective. 

Now what about the stock market? For those who have followed me, I don’t like current valuations. I don’t like the lack of market breadth. Indeed, my personal investments have been geared towards benefiting from a risk off environment while being out of most stocks. I like gold (again, none of this is investment advice). Now, any “normal” person would say, who cares, you are trying to promote long-term investments and especially if you’re young, the stock market has shown to be a good place to be over the long-term. Maybe, but I cannot in good consciousness recommend to anyone to plug money into the stock market at this stage. Sure, reference the example above, at 0.22% of one’s investment allocation, it may be cheap learning. 

Indeed, if someone says I’ll give a certain percentage to a robo adviser, I’m not going to object to it, even in the current environment: one good thing robo advisers do well is to rebalance a portfolio, a key step many investors forget. I have long preached that ‘doubling down’ in late 2008 was irresponsible for those who had not taken chips off the table during the good times (if you lose half your net worth, it is irresponsible to put more capital at risk), but may be quite appropriate for someone steadily investing and rebalancing their portfolio. 

The reason I have shifted heavily into currency investments over the years is not that I’m in love with the euro (despite what some cynics say!), but that the currency market provides an avenue to generate uncorrelated returns. In an era where central banks have elevated asset prices into what might be bubble territory, and fostered capital misallocation, investors need new tools to have a robust portfolio for what may lie ahead. That doesn’t mean that college kids or sixty year olds should suddenly become currency traders, but it suggests to me we need to think beyond the traditional asset allocation. Gold comes up many times in these discussions; it’s not that gold is so much “better” than many other investments, but it’s much easier to grasp the potential diversification benefits and understand the risks of gold than of long/short equity or long/short currency strategy. However, in the same spirit of diversification, an investor should consider gold instead of or in addition to an investment in something completely different, say a storage business (I’m tempted; I have friends who have done it – tenants don’t complain and you can sell their stuff if the monthly lease payment doesn’t come). Did I mention my wife is developing a vineyard? 

My goal here was not to get your portfolio into perfect shape, but to get you out of your comfort zone, to get you thinking. Let me know whether I succeeded. On the topic of gold, we have a webinar on Thursday, September 21 (click to register). If you believe this analysis might be of value to your friends, please share it with them. Follow me on LinkedIn or Twitter.  

Axel Merk 
President & CIO, Merk Investments

http://www.merkinvestments.com/index.php