The Investor: Students Fail at Stock Picking, but Learn the Important Lesson

At the start of the semester I give the students one-page backgrounders from a stockbroker of about 25 New Zealand shares. I ask them to choose a share they think will perform well over the next 14 weeks. I also assign another share to each student, and put them into one of five portfolios of five shares.

The day of reckoning is the last lecture of the semester. And this year it was a rude shock for some. Air New Zealand - the second most popular share, chosen by 56 of the 350 students - came dead last. Its return over the period, including dividends, was minus 14 per cent, perhaps because of rising fuel prices.

Meanwhile, the best-performing share, NZX, which was chosen by just three students, produced an astonishing return of 55 per cent.

Other popular shares also performed badly. The favourite was Fletcher Building, whose 3 per cent performance ranked 20th of 25. And third favourite, Auckland International Airport, ranked 18th.

Small wonder that when I asked for a show of hands on whose share had performed better than the one I had assigned to them, only about a third of the class responded.

I hastened to tell the students that in other years it was closer to half, which is what you would expect if you believe – as I do – that stock picking is basically a game of luck. This year the students had unusually bad luck.

But the main point of the lesson was not about picking shares but about diversification.

When we looked at the performance of the five portfolios, they ranged from 1 per cent to 22 per cent – a much narrower range than the minus
14 to 55 per cent for the single shares. And for the “whole class portfolio” of 25 shares, the return was comfortably in the middle, at
9 per cent.

The message? The more shares you invest in, the less the total volatility, because the good offset the bad and vice versa. Sure, you miss out on the big highs. But research shows that most people are willing to do that if they also miss the big lows.

There was, though, one concern with this year’s results. I didn’t want students to go away with the idea that a three-month share investment usually brings in around 9 per cent. I had already told them that you really need ten or more years to invest in shares. But would they forget that?

Fortunately, I had to look no further than the previous year’s results to make my point. In that semester, the single share returns ranged from minus 29 to 6 per cent, the portfolios ranged from minus 8 to zero per cent, and the whole class portfolio returned minus 4 per cent. Not pretty.

I also showed students how different the three-month and ten-year returns can be for a given share. Air New Zealand, for example, averaged nearly 13 per cent a year over the last ten years, and Fletcher Building averaged more than 20 per cent. Their recent performances were far from typical.

Lesson done, I had just one problem. Most of the chocolate fish I had taken along as prizes for the clever share pickers were not awarded.

I had to resort to giving booby prizes for all those Air New Zealand fans.