What I'll teach my son about investing

Dear Son,

I've left you an amount of money that should either help you pursue your interests or be a backstop if something unexpected occurs.

This letter is "just in case" I don't live long enough to see you come of age and it's about investing.

Your gut reaction to the word "investing" will determine where you go from here, so I've imagined your three most likely responses.

1. No interest

The first is that it turns you off completely. Perhaps your interests and aptitudes lie elsewhere and the world of finance and investing is something you actively dislike or at least have no desire to learn about.

So, now you have access to this money but little interest in managing it. That's OK. I hope that one of the things you've learned in life is that delaying gratification can be rewarding.

That being the case, I recommend a one-off effort to follow this advice. After that, things should be relatively simple. I'm asking that you educate yourself on the importance of costs as they relate to investing.

Read John C. Bogle's book Common Sense On Mutual Funds: New Imperatives for the Intelligent Investor.

Don't worry if you don't grasp it all but the recurring message is a crucial one for anyone in your position: understand why costs matter so much to an investor and where you might find funds that minimise them. Then you'll be in a stronger position to invest the money passively in an effective manner.

Combine this approach with a good accountant who can keep track of any distributions the funds pay and advise you on the best way to invest (in your own name, for instance, or through a company or trust, etc). And that's about it.

With this set-up, the money should grow over the years and be there if you ever need it while imposing only a minimal administrative burden on your life.

2. A passing interest

What if you have a passing interest in investing? In this case, I recommend identifying a couple of talented fund managers who are applying a value-investing approach to the sharemarket.

The place to start is the book that changed my life, Buffett: The Making of an American Capitalist by Roger Lowenstein.

It's an easy read that introduces the core concepts of value investing without being dry or theoretical. You'll get a flavour for the different value-investing approaches and some of the quirky personality types who often ply them.

After that, find a copy of an essay by Warren Buffett titled The Superinvestors of Graham-and-Doddsville. You can find it on the internet or in an appendix to many versions of The Intelligent Investor by Benjamin Graham.

In it you'll see the track records of several successful value investors. Pay close attention to those records, especially Charlie Munger's. Have a look at his returns year by year and note the results from 1973, 1974 and 1975. This kind of variation (-31.9%, -31.5%, +73.2%) is also reflected in the results that I have achieved. I'm not comparing my intellect to Munger's, just my investing style (to invest heavily in my best ideas).

Even ultimately successful value investors can go through difficult patches where their results lag the market for years. But if they're applying the philosophy well, then over time you are likely to be fine unless their fees are unfair.

Some talented money managers have rapacious fee structures. Their investors may still do OK but my preference is for managers who go out of their way to look after their clients' interests. They are rare but I believe you will be able to find them if you look.

I expect there will always be great fund managers out there hungry to prove themselves not for the money but mostly for the thrill of "the game". Probably they will be running smaller funds (which is a significant advantage).

Find a couple of talented, hungry managers who are charging fair fees and invest a meaningful amount with them for the long term (they should be significant investors in their own funds, too). Perhaps leave a fifth or sixth of the money in cash as an emergency fund and then hand the rest to the fund managers you have selected.

Give them at least a few years to perform and don't be shy to provide encouragement, especially in the tough times.

But make it general in nature. Don't second-guess their individual investment choices. Once again, you'll need a dependable accountant.

3. Got the bug?

If you get butterflies in your tummy when you hear the word "investing", then you've probably got the bug, like your old man.

I've given much of my life to financial markets. From age 18 until 33 I probably averaged at least 12 hours a day either working within financial markets, formally studying them or informally educating myself.

While I wouldn't necessarily recommend that, when you're as consumed by a passion as I was for investing, you can hardly stop yourself.

If this sounds like you, then I recommend reading the greats. Start with the Buffett biography I mentioned earlier but also read every one of his letters to Berkshire Hathaway shareholders (in chronological order, from the earliest). Read speeches given by Munger.

Read Fooled by Randomness and The Black Swan by Nassim Taleb. Both James Grant (of Grant's Interest Rate Observer) and Jeremy Grantham have played important roles in shaping my approach.

There are plenty of others but you'll find them yourself if you're on this path. In terms of formal learning, study accounting. Also try to acquire a good basic knowledge of commercial law and psychology.

Collective delusions and crowd psychology play dominant roles in markets from time to time. Just in my lifetime we've had the 1987 sharemarket crash, the "dot-com" bubble and the GFC.

Such cataclysms represent life-changing opportunities for the prepared value investor. At these extreme points, much wealth changes hands. Learn how to position yourself to take advantage of the handful of such opportunities that will arise in your lifetime.

Being conservative with debt is a big part of it (I haven't borrowed from a bank in almost 20 years). Having the financial capacity is step one.

But having the right psychology is also crucial. Buying amid panic can be deeply disconcerting.

I don't want to get too "out there" but cultivating ways to control your own mind's excesses will help. This might be through some form of reflection or meditation, performance coaching or even physical exercise (read Josh Waitzkin's The Art of Learning for some insight into this).

Finally, when you "click" with someone else who has the value-investing bug, make an effort to keep in touch. Having like-minded people to grow and learn with is invaluable, not to mention fun.

And while you're at it, enjoy your ride on this planet. I did.

Love always, Dad

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