The American educational system prepares our children to be successful in whatever field of work they choose. But that is not true of the popular “stock market game,” which has been hijacked by the brokerage industry to indoctrinate students into disastrous financial practices.
Do some of your clients or prospective clients shun the thought of owning broad stock index funds in favor of particular hot stocks they believe are a sure thing? Or maybe they just want to own certain industries in which they are confident. If so, perhaps they are among the 17 million people since 1977 who were exposed in high school to something called the stock market game. The game is pitched to teachers of classes from 4th to 12th grade as helping students learn financial literacy. You be the judge as to whether it actually does.
The stock market game
The stock market game (SMG) is a program of SIMFA’s Foundation for Investor Education. The foundation’s website says it is “an educational non-profit organization dedicated to fostering knowledge and understanding of the financial markets for individuals of all backgrounds.” That is a very worthy cause and perhaps why it qualifies as tax-exempt.
I spoke with Jim Ford, a paid market coordinator for the SIFMA game. He covers four states, including my home state of Colorado where my son has played this game twice before entering college, and a version from a different sponsor just a few weeks ago in college. I’m very proud to report that he scored 119th out of 120 students, but more on that in a bit. The rules of SMG are as follows:
1. Students start with $100,000 in “fake” money.
2. They can margin up to 50%, meaning they could have $150,000 of securities. The margin rate is 7% annually.
3. The game lasts 10 weeks, though there is a version that goes for up to a year.
4. Students must buy a minimum of three securities and each security must be priced at least $3 a share.
5. Trades incur a 1% commission to buy or sell, irrespective of the security, whether individual stocks, mutual funds, or ETFs. Ford noted that this discourages churning.
6. The winners are the students who make the most money during the duration of the game.
Ford told me that the SMG is an “exciting” way for students to learn investing, including fundamental and technical analysis.
Game theory in SMG
Over any 10-week period, or a full year for that matter, a broad stock market fund such as the Vanguard Total Stock Market Index Fund (VTSMX) has a zero chance of winning this game, and is likely to just turn in a slightly above average score. Yet, according to Morningstar, it bests 88% of U.S. equity funds over 15 years and that doesn’t count the funds that went out of business (survivor bias). It would also fail Ford’s “exciting” criteria because it takes on no uncompensated risk. When I asked Ford about this, he told me that a total-stock fund would be “overdiversified.” After pressing him on what he meant by that term, he explained it would be overdiversified for this game.
I was in heated agreement.
To win the game, the opposite would be true – take on the most amount of risk. To do that, the logical conclusion for maximizing the probability of winning would be to build the portfolio as follows:
- Take out the maximum margin loan immediately.
- Buy the minimum number of stocks (three).
- Pick the most volatile stocks trading at or above the minimum required $3 per share price.
Of course, while this maximizes the probability of winning, it also maximizes the probability of huge losses. No matter, the SMG has no negative consequences since losing half the game money is no worse than having a 10% gain on a stock index fund.
I was proud of my son coming in second to last of the 120 students in his college class because he understood the rules, consequences and game theory. In the game he played (a game with different rules and not affiliated with the SIFMA), he bought futures, options, shorted stocks and managed to lose $353,000 of his $500,000 imaginary money. Kevin, a seasoned investor since second grade, assured me that he would “never invest real money that way.”
In short, the SMG and investing incent participants toward opposite goals:
- SMG – Maximize volatility to increase probability of winning.
- Investing – Minimize uncompensated volatility (and fees) to maximize risk-adjusted return.
In addition, the SMG is exciting while investing can be downright boring.
What is the motivation behind the SMG?
Why would SIFMA want to teach maximizing risk? SIFMA stands for the Securities Industry and Financial Markets Association. Well over half of its 520 members are broker-dealers. The SMG provides great benefit to those broker-dealers. If students do well in the game, they could take away the lesson that investing is easy and become a day trader. If they do poorly, they might learn the opposite lesson and believe that picking stocks is so difficult that they need to hire a broker to buy individual securities.
I view the SMG as yet another version of the financial services industry’s game of “heads we win; tails we win more.”
What can be done?
Imagine if you’ve been talking, reading, and writing a language for 30 years and suddenly the dictionary changed and words had different meanings. It would be harder to relearn reading than if you started from scratch. It’s the same with investing because our learned beliefs, such as whether we can know when rates will rise or which companies or sectors are growing faster, are the things that need to be relearned as well.
The good news is that we are unlearning. The index fund was only about one-year old in 1997 when the SMG was launched. It was called “Bogle’s folly” by its competitors and seemed destined for failure. Today, BlackRock estimates that about 18% of global stocks are owned by index funds. That’s good for investors but not so much for broker dealers.
And there is more good news. Another not-for-profit is working on a new stock market game. NextGen Personal Finance is a four-year old non-profit that hasn’t taken money from the financial services Industry. Its founder, Tim Ranzetta, estimates the organization has now reached over one million students. Ranzetta said its new stock market game will compress 40 years of investing into 15 minutes. He told me “the investing world has changed dramatically in the last decade and the popular investing games played in high schools across America have not. We look forward to giving students the skills they need to be successful investors, as they will need these skills given that traditional pensions have disappeared.”
Allan Roth is the founder of Wealth Logic, LLC, a Colorado-based fee-only registered investment advisor. He has been working in the investment world with 25 years of corporate finance. Allan has served as corporate finance officer of two multi-billion dollar companies, and consulted with many others while at McKinsey & Company.
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