With a day to go before the end of 2014, it’s also about time to renew my “contract” with my younger siblings for another year. If you’re wondering what I am talking about, let me explain. My siblings received a small inheritance a few years back and I was tasked with helping to manage a significant portion of it, about $20,000 each for the both of them. And these funds are made less liquid for them since I have also imposed some conditions regarding the withdrawal of these funds.
This renewal was supposed to be a simple annual affair but I started having second thoughts on the agreement after reading this post written by La Papillion. In his post, he was sharing his experience after issuring his own “bond” to his parents. I commented on it and also revealed that I was offering my siblings a simple and straight return of 5% a year. In the ensuing discussion, I couldn’t help but get the feeling that I was being too “generous’.
Which is pretty amazing since when the “contract” was first drawn, my initial thoughts were that I was probably short-changing them. That’s mainly based on the assumption that the market earns a return of 10% a year on average and that over time, 70% of the funds should be invested in stocks for most periods. On the other hand, even I have to admit that I would be tempted if there’s an opportunity to invest in a relatively liquid instrument with a guaranteed 5% return.
So instead of forcing this “contract” down their throats for another year (oops), I thought it might be better for me to offer them various structures to determine their returns. So here’s some of the possible options I have in mind and my assessment of them are based on my dual role of fund manager and elderly guardian of their money. (Talk about conflict of interest…)
1. A Flat 5% Return
Simple and appears reasonably fair – a 5% fixed return for an instrument that is definitely more liquid than our CPF funds is definitely appealing even to myself. There wouldn’t be a need to report the returns of my own portfolio to them too.
Unlimited upside for me – If Ithe market/ do well, I get to keep all the additional returns (above 5%) for myself
Unlimited downside for me – In a weak market or if I pick the wrong stocks, it’s a double whammy. Besides suffering losses myself, I would have to cough out an additional 5% for their investments.
No interest in what I am doing – I do hope that one day, they will be interested in creating their own financial roadmap and be capable of managing their own money. However, there is no incentive for them to know or learn further about how I invest since they are not involved in any downside or upside.
2. Warren Buffett’s Partnership Structure
“I got half the upside above a four percent threshold and I took a quarter of the downside myself. So if I broke even, I lost money. And my obligation to pay back losses was not limited to my capital. It was unlimited.” – Warren Buffett
Limits downside for me – In the event of a market crash and the portfolio sinks by 40%, I would only be responsible for 10% of the loss.
They have a chance to participate in potential upside – If I am able to achieve 9% annual returns on average, I will get a good 2% as fees and they get a not-bad return of 7%.
Involves complicated formulae to calculate return – I haven’t really been that disciplined in calculating my portfolio returns. Additional efforts would have to be made to record transactions to calculate an XIRR or a time-weighted return, Not that bad since regular passive income updates on this blog would help me to obtain a good estimate.
Prospect of negative returns for siblings – That’s the trade-off if there is no guarantee from me
3. Same Returns as “My Passive Income” minus a small fee
Not seen as taking advantage of siblings – Assuming the fee is a small 0.5%/year (~$100), I am not taking much away from their returns.
Feel the full effects of the market – Good when the bulls are around and bad when the bears prevail.
I despise such a structure – It’s a matter of principle. It just doesn’t sound right that I will be renumerated regardless of my performance. But then, that’s the structure of most investment funds. =p
Would appreciate any views/comments since it’s likely to be more objective? My siblings will be reading this article and all of us will appreciate any advice. =)