Many personal finance teachers do their students a disservice by signing their classes up to play “the stock market game“.

Usually sponsored by financial institutions, stock market games allow students to create investment portfolios of stocks, and then track them over a short period of time.  At the end of the period (whether it’s a week, month or a quarter) a “winner” is declared based on whose portfolio increased the most over the study period.

Some teachers, to their credit, try using the exercise as a teaching tool. 

But those teachers are making a mistake. 

Counting short term successes and losses in a virtual stock market contest stirs an emotional urge that overshadows any educational benefit the students might be receiving.

It’s like teaching children how a casino works by encouraging them to play the games and declaring a winner at the end of the day. 

Do you really teach kids how the casino works? 

Or do you end up tempting them with the “success” they see around them: the odd jackpot earned, while whirling lights and sirens go off for somebody at the slot machine next to theirs?

The stock market game does similar damage. 

Even the students who lose money will “learn” that easy money can be made in the markets over a short period of time.  Why wouldn’t they think that, when seeing that some of their friends made money?

And that’s the seed that financial sponsors truly want to plant in kids.

Some teachers may argue that they’re coupling the stock market game with genuine business analysis.  They might be encouraging their students to research businesses with strong earnings prospects, great brand names, low debt levels or high returns on total capital.  If that’s the case, I commend them for their business sense.

But such businesses, as an aggregate, will perform just as randomly, short term, as businesses that are nearing bankruptcy, with weak earnings prospects, high debt levels and low returns on capital.  The stock market is the friend of the great business and the enemy of the weak one—but only over the long term.  Strong short term business results aren’t going to materialize in short term price differences during the duration of a stock market game.

Over the short term, stock prices are moved by surprises; they’re not necessarily going to levitate as a result of great fundamental business growth.  For example, a superb company could report an earnings increase of 20% in a given quarter, but the stock market price could drop after the news is released.

Short term, much depends on the surprise factor.

For example, if institutional analysts predict that this company will increase profits by 25% during this specific quarter, they’ll sell the stock (resulting in a drop in share price) if the company reports a gain of 20% instead.  In other words, if the company surprises them by not performing as well as they expect it to, they’ll sell the stock, and the price will fall.

Likewise, a terrible business might be expected (by institutional analysts) to reduce its earnings per share by 20% in a given quarter, yet its stock price could skyrocket if its earnings dropped by just 15% instead of 20%.  Analysts would be surprised that it didn’t lose as much as expected, and they would likely rush in with large amounts of institutional money, pushing the stock price up.  Such a surprise, in the eyes of the institutional investor, could be a sign that the company is starting to turn itself around. 

Take the company, Krispy Kreme Doughnut as an example.

Two years ago, I asked my readers to give me a list of crummy businesses—those destined to see their share prices drop significantly.  Krispy Kreme was among those selected by my readers. 

And how have the shares of Krispy Kreme performed over the past 2 years? They have gained 100%.

On the other hand, the share price of the 3M company (a suberb business with rock-solid financials) hasn’t made investors any money over the past 2 years.

You can see the comparative chart below:

Splits: Mar 20, 2001 [2:1], Jun 15, 2001 [2:1] 

Does this suggest that you should look for businesses that you think have poor future prospects and invest with them?

Of course not.

It does showcase, however, how unpredictable the stock market can be, and that great businesses don’t always outperform poor businesses over the short term.

Educationally, fundamental business analysis cannot be taught, coupled with the stock market game.  Teachers won’t be able to make any kind of consistent connection between great businesses and rising stock prices.

If students had 20 years to play the game under the guidance of a great teacher, the story would be different.

Businesses that make money over the long term (as businesses) tend to have stock prices (often coupled with dividends) that make money for shareholders over the long haul—when purchased at the right price.

But over the short term, you might as well be at Vegas.

 I’d like to present a few suggestions for business/personal finance teachers:

1.  NEVER play the stock market game with your students.  It will do far more damage than good.

2.  Teach students why financial institutions want them playing the stock market game.  Financial institutions make more money when people “trade” stocks.  This is the main reason they try bringing the casino to the classroom with addictive games in the guise of educational tools.

3.  Show students how to really make money in the stock market, by teaching them to own a diversified account of low cost stock and bond indexes and/or a basket of blue chip businesses that they commit to for many years.  They must understand that if stock market investing is exciting, they’re not doing it right.  To maximize profits, investors need to be long term thinkers, not short term reactors.

4.  Instruct students on investment commissions and taxes, while demonstrating that even most professional investors lose to the market indexes after all costs.

Some teachers rationalize the stock market game by suggesting that it demonstrates how tough it is to beat the stock market indexes.

Their premise is right, but their method is wrong.

Over a short period of time, half the class could end up beating the market.

What have you done to that group of kids? 

You’ve inadvertently revealed (in their eyes) that they’re stock market wizards. 

And what do you think they’ll do with their money once they start investing?

They’ll be far more inclined to trade stocks…making (stock market game) sponsors such as Merrill Lynch, Wachovia Securities, A.G. Edwards and Morgan Stanley very happy indeed. 

Most importantly, young people need to understand that rising stock markets aren’t good for them.

They need to recognize that stocks are real businesses.

As long term buyers of real businesses, young people should much prefer sinking stock prices, not rising ones. 

After all, as long term accumulators of stock market assets, they shouldn’t be celebrating when the products they’re collecting for their portfolios are getting more expensive to buy.

Stock market games undermine this premise.

I discuss how young people should think about stock market movements in my book, Millionaire Teacher while showing how to effectively invest in the stock market.

I only wish that more personal finance teachers become cognizant of the role they’re really playing when encouraging stock market games with their kids.

If you have a contact in a school, please forward this article to them.  With luck, they’ll send it their school’s business teachers.