By ROBIN POWELL
As any parent who’s had to juggle paid work with home schooling during the lockdown will tell you, educating children isn’t easy. Good teachers aren’t given nearly enough credit for what they do.
The biggest challenge is getting pupils to understand that true learning comes through discipline and effort — and learning to think for themselves.
Only with hindsight do we see the point
Can you remember being confronted for the first time with, say, a Shakespeare play, or the Periodic Table? We didn’t understand it; and we didn’t understand why we were being taught about it. Let’s face it, most of us were pretty underwhelmed.
It takes a highly skilled teacher to inspire us to learn about something when we can’t see the point of it.
Only with hindsight can we appreciate the value of what we learned and how it helped to shape who we are.
Financial education is no different
It’s the same with financial education. There are so many tempting things for children and young people to spend their money on. They need to be persuaded that wealth is a scarce resource, and there are opportunity costs to every purchase.
They also need to be taught that there are only two reliable ways to build their wealth. The first, and most important, is to nurture their earning power, or human capital; the second is to develop the habit, as early as possible, of regular investing.
Educating or harming?
Good investment education, at least in the UK, is virtually non-existent. Insofar as it does exist it focuses on picking stocks, which is not just non-sensical, but potentially downright harmful.
Parents who show children how to research, buy and sell shares, or allow them to take part in stock picking contests, might think they’re doing them a favour. They’re actually tickling gambling bones and encouraging bad behaviours.
Instead of teaching them the value of frugality and patience, they’re simply reinforcing the idea in their children’s minds, prevalent in contemporary culture, that it’s better to take a short cut.
The number one lesson
The most important lesson for young people to learn about investing from the outset is this: although we can disagree on the precise extent, global stock markets are actually very efficient.
Very few full-time professional money managers consistently beat the market in the long term. The idea that a teenager can expect to do any better through genuine skill is totally preposterous.
For some young people it’s bound to be an uncomfortable truth. They’re constantly reminded on social media of others their age making a quick killing through stock trading.
But realising that what we want to hear and what we need to hear are two different things is an important part of growing up.
One of the most valuable things you can
Alongside teaching your child to eat healthily and stay physically active, showing them how markets work, and, crucially, how they can make markets work for them, is one of the most valuable things you can do for them.
The good news, is that, to quote the author William Bernstein, “the body of knowledge that the individual investor, or even the professional, needs to master is pitifully small.”
But how do you start? Whether you’re a teacher or parent, and whether the “child” in question is 15 or 35, may I suggest that you start by showing them this video on investing and market efficiency?
In Part 2, with Professor Stolin’s help, we’re going to provide a lesson plan to accompany the video.
For now, though, just watch. The video is less than four minutes long and I hope it will raise a smile. And, who knows, it might just change your child’s life for the better.
Oh, hi! You know, if people see you with a finance textbook like this one, they’ll probably start asking you for investment advice. They’ll be asking you questions like, which stock should I put my money in? Well, the obvious answer is, in a stock that is going to go up in price. Wow, that’s really smart, can you also explain gravity to me? The question I have for you is, how do you know? If you say “well, because it’s obvious”, that’s not a good reason, because if it’s been obvious to you, then it’s been obvious to other investors before you. These investors will have been buying the stock, and the more they bought, the higher the price went, until there was no profit left for you, Captain Obvious.
Now, if your reason is “because I know something that others don’t,” it had better be legally available information, otherwise you could go to jail! And I will make that call, trust me. And if it is legal information, then why aren’t others using it? In that case you could say, well, the information is legally available, but others are not smart enough to use it like me. You are very confident. Do you crossfit?
The problem is, there are a lot of professional investors who are competing with you for the same profit opportunities. They probably have better training, better resources and more money at stake than you. Going against them is like going against a professional MMA fighter, when you just shadowbox at the gym on Saturdays. It’s a dumb idea.
Now you could say, how about I give my money to a professional to invest, so they pick stocks for me? This sounds pretty smart. The problem is, your professional is competing against all other professionals, and since all professionals put together pretty much hold the stock market, this means that the average professional is expected to give you the same performance as if you simply put money in the stock market, without trying to be clever except that you will also be paying them fees for their trying to be clever. Not as smart anymore, is it?
Then what if you give your money to a professional who you know is going to outperform the market? Now I ask the same question as before: “How do you know? Where are you getting this information from??” If you look at historical data, the chance that a professional investor who beat the market in the past will do it again in the future is pretty close to 50/50.
But suppose you do find such a professional who consistently beats the market. First, give me their name. Then ask yourself this: if they are so smart that they are for sure going to help me beat the stock market, why don’t they charge higher fees? Until their clients like me keep only a tiny bit of the profits and they keep the rest? That’s what would happen.
If you don’t have a good answer to this last question, it’s clear what you should do: just cheaply invest your money in the entire stock market. As they say, if you can’t beat them, join them. They say that. This is called passive investing. To do this, simply google “index funds”. Trying to beat the market is called — you guessed it — active investing. A market that’s hard for active investors to beat is called efficient.
Passive investing may sound great to you right now, but there is a paradox that you should be aware of. It’s called the paradox of market efficiency. The more money that’s invested passively, the less money there is for hunting profit opportunities, so the more profit opportunities there will be in other words, the less efficient a market becomes. But these profit opportunities make it easier for the best active investors to outperform, and this attracts more money to active investing. And the more money active investors have to hunt profit opportunities, the rarer these opportunities will become, so then active investing looks less appealing and the market becomes more efficient. So it goes in a cycle.
In other words, there will be profit opportunities at least from time to time but unless you want to spend a lot effort figuring out where they are and who is making money off of them and how you can make money, too, you should just invest in index funds. I know, I could have said this at the beginning. But you watched the whole video, so now you are smart.
Now if you do want to figure all of this out — well, keep studying finance. Because that’s what I’m going to do.
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