Earlier this year, I was offered an opportunity to be a financial literacy mentor for a sixth-grade class at a Denver-area elementary school. Part of the program was a “stock market experience” allowing participants to build a mock portfolio and, at the conclusion of the program, see how well they performed compared with other Colorado-based teams.
The rules were straightforward: Each team was allotted $100,000, allowed to make a total of 300 trades and almost any security was eligible for inclusion. I was extremely pleased that our team came in fifth place, and came very close to winning (although at this time, the results are still unofficial). In retrospect, the four lessons imparted to these young investors may be helpful reminders, even for today’s most seasoned professionals.
Lesson One: Simplicity often trumps complexity. After an initial consultation with the teacher, we mutually decided to set some of our own rules, including no trading after the initial purchase, no margin and no derivatives. While it is doubtful that sixth-graders would have understood these concepts anyway, our approach was to allow the class to research and buy eight to 10 stocks. Since the time horizon was two months, we also decided not to change the mock portfolio during the experience, and let the chips fall wherever they may.
Lesson Two: Patience and conviction. Halfway through, one of the positions had an extremely disappointing earnings report, and the stock fell 14%. Despite the ground rules we established, I received an email from the teacher as the class wanted to know if they should sell. This reaction is perfectly reasonable and, while I did not say no, I did tell them that they would need to be right twice: once for the sale and then again to buy something else. On their own, they decided to stay the course and hold. While the position still ended in the red, by the time the experience ended, the loss was just 8%.
Lesson Three: Dividends matter. With only a two-month time horizon, we ignored dividend yields, but when reviewing the mock portfolio’s final performance, everyone was very happy to have received dividends from some of the positions. Financial theory informs us that the stock price should have dropped by an amount equal to the dividend, but in behavioral theory that doesn’t always matter. People like receiving dividends, as the “bird in the hand” axiom plays an important role in investor behaviors.
Lesson Four: The power of diversification. I was going to put my foot down if every selected stock had something to do with video games or hand-held technology. The good news was that the class selected stocks from a wide range of industries, including retail and consumer durables, without any nudging from me. The lesson of diversification was strongly reinforced as the mock portfolio only had one losing position.
Finally, I would be remiss to not share that with one trading day left in the contest, my class was in first place. I was tempted to call an emergency meeting and suggest going to cash, locking in gains and removing any last day downside volatility. Then I remembered that Ted Williams did not “sandbag” on the final day of the baseball season when he was pursuing a .400 batting average – he played. So we played, came in fifth, but walked away with these four important lessons that hopefully will help educate the next generation of investors.