Lessons From the Stock Market Game

I came home last night to find our ten year old sitting at the computer looking up stocks on Yahoo! Finance. When I asked him what he was doing, he told me that they’re playing a stock market game at school, and he needed to find some good companies. The rules are that they have $100k to invest, they can’t buy stocks that cost less than $5/share, and they have to buy at least 100 shares of each company.

When I asked him how long the game would run, he wasn’t sure, but it’s not terribly long. Thus, on order to perform well in this game, you have to choose stocks that will perform exceptionally well over the next few weeks/months, as opposed to focusing on what really matters. In fact, I’d be willing to bet that the winner will be someone who chooses a single stock that happens to perform exceptionally well.

While I’m thrilled that they’re talking about this stuff in fifth grade, I wish there was a better (more realistic) way of teaching kids about investing — one that wouldn’t send the wrong messages. Despite these limitations, I decided that this would be a good opportunity to start imparting some wisdom. In fact, his savings account has built up to the point that I’ve been planning on teaching him about “real” investing sometime soon (though we’ll rely on index funds as opposed to individual stocks).

What follows is a list of some things that I hope to help him get his head around…

The importance of diversification

At first, he was focusing in on finding that one “right” company. While this might work out fortuitously in the short term, it’s definitely not a good strategy overall. After explaining this to him, he seemed to recognize the risks…

“Oh, like if I put all my money money in Google, and then terrorists decided to blow it up, I’d lose all my money.”

Exactly. I also suggested that he might want to pick companies that are in different industries.

So far, these are the companies that he’s most interested in:

  • Visa (V)
  • Yum! Brands (YUM)
  • Procter & Gamble (PG)
  • Apple (AAPL)
  • Exxon/Mobil (XOM)
  • Google (GOOG)

When I suggested the possibility of a drug maker, his eyes lit up and he asked:

Who makes cocaine?

Hah.

Price alone doesn’t make a stock expensive/cheap

While he’s not allowed to buy shares under $5, and needs to keep a lid on the upside due to the $100k total limit and the requirement to buy at least 100 shares, he’s still grappling with the fact that a $10 stock isn’t necessarily “cheaper” than a $20 stock. He’s probably going to end up skipping Google simply because he can’t buy 100 shares and still keep a balance portfolio. But aside from those sorts of limitations, there’s no need to avoid (or favor) a stock solely because it has a high (or low) dollar value.

Likewise, he needs to learn that a $5 increase in a $50 stock is the same as a $10 increase in a $100 stock. This shouldn’t be too hard, because he’s actually quite good at math — I think I simply need to point it out to him. Nonetheless, while evaluating stocks, he was dazzled by the dollar changes without regard to the underlying share price.

The importance of thinking long term

As I noted above, the stock market game that he’s playing encourages short term thinking, which had him looking at yesterday’s performance as an indicator of whether or not a stock was doing well/poorly. Down a few bucks? Wow, that’s a bad stock. Up a bunch? Looks like a winner. To help him understand the relative unimportance of performance over a short timeframe, I zoomed out from the intraday stock chart to show him the 5 year chart. That definitely provided a bit of perspective.

The “buy low, sell high” mentality

This is related both to the issue of pricing, and to the importance of thinking long term. As seasoned investors know, a short term decline isn’t a reliable indicator of a bad stock any more than a run up indicates a good stock. While I realize that I’m oversimplifying things here, some of the world’s greatest investors have made their money buying downtrodden stocks (or buying into downtrodden markets) and waiting for a recovery.

Anyway, this should be a fun little exercise for both him and me.

14 Responses to “Lessons From the Stock Market Game”

  1. Anonymous

    So true about thinking long term… the stock market game the kids were playing is great and all, but focusing on short-term profits is likewise short sighted. Teaching kids about simple dollar-cost averaging by itself would go so far. Be patient and over time it’s hard not to make money.

  2. Anonymous

    Yes, I’m constantly buying into the downtrodden markets.
    (Yet, to pick a stock that hasn’t increased in value over the last year – ho, hum – I’m in it for the long term)

    Much to my husband’s disgust who just view the short term gains of share prices & him a Statistician (naughty boy).

    BTW, love the comment about cocaine!

  3. Anonymous

    The stock market is the last thing a child should learn when it comes to money. They should learn where it comes from, how to save, credit, what is means to invest, how it should be viewed, etc. Just playing the market gives them the mentality that it’s all about picking stocks to make money, and it’s all too easy to do – right!

    Again, the educational system does things backwards.

  4. Anonymous

    I wish more schools were like your sons. It seems to me that school don’t teach two very important lessons.
    1. How to handle your money. Things like setting up an emergency fund, saving for retirement, and spending your money wisely.
    2. How to raise your kids. How to prepare your family for a financial crisis and raise them on proper priciples.
    Two things I feel are society could use more of.

  5. Anonymous

    The NASDAQ visitor’s center in New York City has a computer game at the end where you “buy and sell” stocks as it runs through a year timeline. At the time I think it was based on the past year’s historical data (duh!).

    I thought that was so fun!

  6. Anonymous

    I am a newbie in stock market investing. With the current market trend of a bear market, definitely I would implement the short term investing and the right timing when to buy and when to sell. As always, the golden rule in stocks is buy low sell high.

  7. Anonymous

    It’s good that it will get him thinking about the Market but as you’ve already said you’ll have let him know this is not a realistic way to invest – if he wants to make any money.

    For the sake of the game – I like MVL under $33 – the Ironman Blue-ray is flying off the shelves

  8. Anonymous

    Alain, I agree and disagree about visa. it is getting hammered lately for no apparent reason (thus I’ve been buying and buying visa) other than a peripheral relationship to the credit markets. despite continued indications that people are continuing to use cards heavily (this means both debit and credit), visa has been getting hammered. i think it is part that it is newer than mastercard and doesn’t have several quarters of earnings under its belt yet. i think after next quarter’s results come out, visa will do very well and stabilize.

    Anonymous, Apple is a high end retailer in that they charge full retail price with a pittance for discount (e.g. student discount). Apple already realizes that they are being hit hard. much will be seen with the new mbp and macbook due to come out rumored this month or nov and their pricepoints. indications that the macbook will be more affordable will be good; however, since they do not discount, and the way that discretionary spending has shriviled up, apple will be seriously affected over the next 2-3 quarters or more.

    i have JNJ and they are good for stability and longer term growth and a decent dividend, but for a short term i don’t think it will win any awards.

    i’d look at discount retailers, but not until after this next quarter is reported. i think retailers as a whole will plummet and then discount retailers will be the ones who get earnings after this quarter’s reporting.

    definitely for short plays, i would go with something like Citi, but only after the short sale ban is lifted. although it has increased, from it’s pathetic lows in the 12’s, i am very wary once the short sale ban is lifted 3 business days after the rescue/bailout takes affect. I just think there will be lots of hedge funds wanting to recoup losses as a result of the short selling ban, and citi was being run down before the ban and i can see hedgies and the like taking one more swing at it.

  9. Anonymous

    I think the stock market game is a bad idea unless there aresome seriously reinforced financial principles and realities involved. For 5th graders, the stock market game does not teach anything about financial responsibility and i would contend teaches recklessness over anything else. The stock market game teaches kids how to get rich quick; to take higher or unnecessary risk than the would normally if it was real money because the name of the game is the winner is who has the largest portfolio over the very short period of time, even if the game lasts a couple of months; the fact that it is no real money that the fifth grader has had to earn to put in the game.

    we had the same game when i was growing up. i chose good companies with long histories of solid earning like Dunn & Bradstreet (man have you seen their chart for the past 25 years?); however, as i saw that although these companies had solid long histories of earnings, it wasn’t going to get me to victory in the short period of time. So what turned out to be good starting principles, ended up being very bad lessons learned. i can honestly say that until right now, I have never thought about buying Dunn & Bradstreet (DNB) again. I can see that my stock choices and attitude towards stocks have been short term rather than long term. I do attribute this to other factors, but I cannot count out that my relationship with stocks during the stock market game in elementary school didn’t somehow shape my relationship with stocks afterwards.

  10. Anonymous

    I beg to differ with you Alain… My husband is buying an iPhone next week and I bought an iPod Touch in Feb 2008, but I do see your overall point, we might be unusual.

    I have done the “pick 5 stocks and watch their progress” with girl scouts grade 4 and you are right, it is far from teaching anything realistic. It does get them to be looking at stocks and the thought that goes into what is good or bad bet.

  11. Anonymous

    For the drug maker, I think Johnson and Johnson would be a solid pick for this volatile market. Your son should be able to identify with the company since they are the maker of Tylenol.

    Visa in the short term will continue to get hammered as this credit crisis continues. Perhaps Bank of America or JP Morgan?

    Apple would be a great pick in a strong economic environment where people have access to discretionary income. But as you know, no one is buying anything these days except for food and gas. I see Apple underperforming in the near term.

    The other picks are solid (GOOG, PG, XOM, YUM). Good luck!

  12. Anonymous

    This only really applies peripherally, but I’ve actually put a good amount of thought into a “stock market game” for kids that can really teach smart investing techniques in a short period of time (1-2 months). What I’ve come up with so far:

    1.)100K per student, to be invested as they see fit.
    2.)Have a preset list of companies that have all been around in the last 20-30 years. Also have a large list of mutual funds, some with loads, no loads, varying expense ratios, active management, passive management, etc.
    3.)Come up with a list of how each company did (as a percentage) each year of the last 20-30 years.
    4.)Put pieces of paper with the last 20-30 years written on them. Pull one paper per day, and adjust the values of each investment as a percentage of their previous value. Return the paper to the hat when finished.
    5.)Then, take trade requests for that day. If the trade involves a stock or ETF, charge a set commission per trade. If it is a loaded mutual fund, charge the load. All expense ratio charges will be charged at the beginning of the day.

    Pros:
    * By using the last 20-30 years as a guide, you are using real world examples. It also includes great leaps and falls for the stock market.
    *Commissions and loads will add up quickly, especially for the high turnover traders.
    *The chances are very high that a balanced, low cost, index portfolio rebalanced annually will outperform the wild swings of the other traders, teaching good long term investment strategies.
    *It allows you to compress a huge amount of time into a small month or two, by representing each day to equal a year.
    *It can be done at the beginning of each day, then not focused on for the rest of the class allowing for further instruction and lessons to be immediately applied to their portfolios.
    *The wild swings would teach lessons about risk tolerance and risk management, as well as the perils of investing emotionally.

    Cons:
    *You must have a preapproved list of companies that have been around the entire time. That way, nobody’s stuck if they bought Google, and you pull 1979 out of the hat. This will weigh the option heavily to large cap well known companies. (Since this is intended as an exercise for basic investing lessons, this is less of a problem than it seems. They can learn more as they take more advanced classes later in life. For now, a good asset allocation strategy is a great lesson) Some index ETFs could be managed into it by using the indexes they track, or you could leave out ETFs all together.
    *The calculations needed would be time consuming. A computer spreadsheet program would take less time, but still require massive amounts of data entry. The least amount of active work for a program would probably require something specifically built for this purpose (FOSS would be perfect, but there would be an initial investment of time/money)

    Any ideas/adjustments?

  13. Anonymous

    I love the idea of the stock market game and I think you gave him some very solid advice. You might suggest that he create several portfolios with different goals for each:
    1) His school project is about maximizing short term gains. This is a legitimate goal but will very likely be won by someone who picks a random stock that explodes briefly (think small banks, tech, pharmaceuticals, companies which are good buyout targets, or whoever would benefit most from the proposed bailout).
    2) Another portfolio’s goal could be to minimize risk and volatility.
    3) A portfolio which maximizes current income and protects the principal investment.
    4) A well diversified portfolio which never loses more than 1-5% of its value.

    You may also want to create your own portfolios to match his so that you can compare notes with your son.

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