Hat tip to NJCFE Financial Capability Upgrade Webinar yesterday. Learned about a quick, easy to implement game with a key takeaway about investing.
The simulation works something like this:
- Ask for a coin
- The flip of the coin will determine if the market is going up (Heads) or down (Tails)
- Ask all students to stand up
- Let them know that they are all financial advisors pulling in $100,000 per year and that their clients are counting on them to increase their wealth. If they do well, they will get large bonuses; if they do poorly they will be fired.
- Now that the students know the stakes, ask them to raise their hand if they think the market will go up in the next period. You might even put their names up on the board before you flip the coin for the first time.
- Flip the coin. If the coin flip is heads, those with hands up remain standing while those who didn’t raise their hand (who thought market would drop) take a seat. If the coin flip is tails, those with their hands raised expecting the market to go up, guessed wrong and have to take a seat. They’ve been fired (here’s a video of the Donald firing them).
- For each successive round, let the people standing know that they are getting richer (house in Malibu, private jets, dining at finest restaurants), larger bonuses, appearing on CNBC and being interviewed on almost a daily basis. Their opinion matters. Continue coin flipping until one person remains.
- Ask the class: Is this the best investor?
So, how do you know whether your investment returns are the result of skill or luck? A renowned researcher at the University of Chicago, Prof. Kenneth French, found that it takes about 15 years to determine whether an investors’ stellar returns are the result of random occurrences or skill (Cautionary tale of how one money manager’s 15 year winning streak ended very badly). So, what’s an investor to do:
- No one can predict the future; and this applies to stocks also.
- Timing the market or guessing whether the market will go up or down is extremely difficult. If you missed investing on the 10 best days of the decade (through 12/31/13), you would have cut your return almost in half!
- Investing in stocks with a short-term time horizon is not unlike flipping a coin; your odds of making money increase significantly the longer you plan to invest.
- It is very difficult for an investment manager to beat the market due to market efficiency and high fees; this study found only about 1/4 beat the market over a 10 year time period. Low-cost index funds that are broadly diversified (think S&P500) provide an excellent alternative to actively managed mutual funds.
- So, the next time you see a headline that roars Stocks to Rise in October be sure to ignore it!