Babysitting Your Portfolio

By Chris Hodge - July 22, 2012 | Tickers: GE, GM, BABY, WMT | 0 Comments

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Before you start thinking this article is going to be about Natus Medical (NASDAQ: BABY), relax. While I do think that the company's 2011 losses and steadily rising administrative and selling costs over the past three years are just a bump in the road, I'm not recommending it for the time being. While medical supplies for young children will continue to be necessary, particularly with Obama's healthcare reforms slowly taking shape, Natus was trading at over 30 times earnings the last time I checked. I like buying discounts, not good stories.

I'm not talking about a particular company with this article, but rather a concept some people might do well to consider.

A few years ago I had the most bizarre conversation with a friend of mine regarding her child's future. I asked if she had a 529 plan setup, and she responded that she was regularly depositing money into a savings account for the little guy. When I asked her why this was, she responded, "I don't want to take the risks of buying stocks and dealing with recessions." I resisted the urge to face-palm because a lot of people never even think about how much time passes between a child's birth and the ensuing college years.

Consider that even in 2012 we're still stinging from the Panic of 2008. Not to sound like a corrupt music file, but times got a little scary. Even auto powerhouse General Motors (NYSE: GM) dropped into the $10 per share range and finally cut its dividend among quarterly losses, miniscule growth and a market that had no sympathy for anyone. You might also remember that even the highly diversified and profitable General Electric (NYSE: GE) had to offer bonds at nearly junk bond levels of interest just to maintain business. In March of 2008 GE was trading at an average of $31.15, and by February of 2009 it was down to $7.70. With such high profile drops that touch almost everybody, it makes sense that a parent would be afraid for their child's savings.

Not to sound like the condescending know-it-all I am, but this is actually a good thing for a child.

Far too many people never even consider how long an economic cycle actually is because of the anchoring bias in psychology that reminds them of the most recent movements of the economy. If jobs are hard to come by now, a lot of people assume that jobs always have been and always will be hard to come by. If stocks have gone down lately, many people assume that they will simply keep dropping forever -- even though there's a decided limit to how far down a stock can go and the extremely low likelihood that a liquid market will tolerate every offering lingering at zero.

Since December of 1854, the longest period between two peaks in the stock market has been 128 months, or just shy of 11 years. The shortest period between two subsequent peaks has been 17 months, or less than a year and a half. With over five dozen data points to go by and an average cycle duration of roughly six years, the likelihood is that there will be at least two to three market peaks between a child's infancy and his high school graduation. When a parent chooses to take the ostensibly "safe" route of keeping their child's college money in cash, they may be leaving a tremendous amount of money on the table for this perception of safety.

With an average market return of 8% per annum in the stock market, $1 invested during the child's infancy will end up being just shy of $4 around his high school graduation. This is assuming the average is applicable every year and that there are no additional stock purchases in the meantime. With continued dollar cost averaging and regular additions like dividend reinvestment, the level of capital appreciation can be even greater.

This isn't just a lesson for parents about letting their children's returns grow. It's also a lesson to everyone about how little most of us really need to watch our stocks. Consider what would've happened if you'd bought some shares of Wal-Mart (NYSE: WMT) for your child in 2000, when the dividend was only $.06 per share, you'd have been past the most recent stock split in 1999. But your price appreciation would have continued with relative steadiness in spite of the two recessions we've had since then. Though there have been rocky times, Wal-Mart is just one of those companies that can laugh off almost anything. Even since 2008, your return from capital appreciation would have been around 51% -- not terrible. With reinvested dividends, you'd be pushing on a 70% rate of return. On top of that, Wal-Mart's dividend has never dropped since its first dividend in 1974, most recently tipping the scales at 36.5 pennies per quarter per share.

I'm not suggesting that you have to buy shares of Wal-Mart, although you won't really go wrong doing so provided you're satisfied with the price you pay. I'm just saying that if you micro-manage your portfolio, you tend to stress yourself unnecessarily. If your kids are 12 today, you've still got time to see boom times and middling times before it's time to start cashing out for their college -- and you still have time to teach them how to apply for grants and join the National Forensic League (which can provide a nice scholarship to kids who stay in all through high school, or at least it did when I was in school).

So take care of your children, and let your stock portfolio basically take care of itself. Wal-Mart's over 40 years old, you know, and by then they can usually handle things for themselves.

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