The NFL and Stock Market Games
We recently had friends over to watch the Lions play the Broncos on Sunday Night Football. During halftime, one of them said to his son, “Ask Coach Eric to pick those stocks for you. This is what he does for a living.” He then explained the assignment was to pick five stocks and the sixth-grader with the best returns over a 90-day period “wins” the contest. My heart sank. The intentions of this game (exposure to financial principles at a young age) are absolutely in the right place but a simulation like this teaches exactly the wrong things to someone learning about investing. Here are the issues:
- Time. Investing over a 90-day period is no different than gambling; you could argue that any money needed in less than five years should be held in cash or high-quality, shorter duration (meaning less sensitive to changes in interest rates) bonds. When the time horizon extends to five years and beyond, riskier exposure (i.e. stocks) may make perfect sense but trying to pick which stock will perform well over the next three months is an exercise in futility. Success in this short window is purely a function of chance and investment strategies should be based on evidence….not on luck. The odds of success in this short window are probably better at the black jack table (but he’s too young for the “free” drinks.) Markets have appreciated in virtually every ten-year period, the same can’t be said for every 90-day period.
- The Transaction. Each trade in the stock market involves two parties; the buyer is trading their cash for a stock and the seller is trading their stock for the buyer’s cash. Institutional trading accounts for a significant portion of the daily volume in the stock market so the odds are high that the seller in a given trade is an institution. Many of these institutions are filled with experienced analysts and portfolio managers spending 100+ hours per week poring over reams of data. Let’s assume you decide to buy a stock. How likely is it that you have better information and have conducted more thorough analysis than the institution willing to trade their stock for your cash? What does the seller know that you don’t? Of course, the reverse holds true after the stock is purchased – when you are ready to sell, the odds are high there’s an institution ready to trade their cash for your stock. You should ask yourself this question before every trade: what does the person on the other side of this trade know that I don’t?
- The Record The evidence suggests that the vast majority of stock-pickers (also called active money managers) underperform markets around the world. Much of this is driven by the higher costs (fees, commissions, taxes, market impact etc.) associated with more turnover in the portfolio. Costs are definitely an issue, but the active approach also means you have to be smarter than the collective market which is comprised of incredibly talented and sophisticated individuals. Again, the buyer/seller is essentially saying that they have information that the seller/buyer of that stock may have missed; while this could happen, it’s extremely unlikely that an individual (or anyone for that matter) can be do this on a repeatable basis. As a financial professional, I get to endure cocktail party conversations where people tell me all about the calls they got right in their portfolio (in the late 90’s it was a “.com” they bought, in the early 00’s, it was real estate they had flipped and then in 08-09, it was how they pulled out of the market the day before Lehman Brothers collapsed); my experience is they don’t remember their misses nearly as vividly so they think success is more repeatable than the data would suggest.
The bright side of the stock market game is this is all “play money” so no harm, no foul…for now. However, the worst thing that can happen to these students is to succeed (which seems so counterintuitive); that reinforces the strategy and leads them to believe that they have some skill that they can exploit someday in the real world. By and large, investors are much better off buying markets, not individual stocks and keeping their costs low all while staying as tax-efficient as possible. There are some similarities to the NFL game we were watching that night – it’s all highly entertaining until you think about the long-term impact on the participants.