Lessons On Index Investing�Part 1 As My Students Learned, Index Investing Is A Great Option To Consider For Those Who Are Beginning Their Investing Journey

I have been very fortunate to pursue my life’s passion—helping others to improve their level of financial literacy—for decades, both in the classroom and subsequently as the president of a financial wellness business. I learned a great deal about how others approach money during my teaching days, and the lessons are worth considering by anyone new to the investing game.

I spent three decades teaching for the Waterloo Catholic District School Board in Ontario and spent half my career in leadership positions such as school-level Head of Business & Cooperative Education and board-level Consultant. I thoroughly enjoyed my time in the classroom. I taught senior financial accounting and cooperative education for decades.

Genius Hour

In the Ontario Curriculum, there is a strand that deals with “Financial Analysis and Decision Making” in both the grade 11 and 12 financial accounting courses that most schools offer. At the school where I taught, “Genius Hour” was supported. This is a philosophy that involves structuring classes in such a way that students control their learning to trigger exploration and find deeper meaning.

Students love to play. Students love to compete. Students love to be challenged. Students love to be put in a position to succeed. Students love to apply what they have learned. Knowing this, I frequently used computer simulations in my financial accounting classes.

The Index Portfolio

I asked my students to choose a partner in class so as to form a team. I gave each team access to two $500,000 stock market simulation accounts. Team members owned both accounts jointly. I covered how to invest using asset mix elements (equities/stocks, fixed income/bonds and cash) to reach long-term goals such as retirement. For our purposes, the simulation accounts would be used for the equity weighting; the accounts needed to be fully invested in equities only. They were then ready to invest inside their index portfolio account using equity index funds via using equity index funds via exchange-traded funds (ETFs). These equity index ETFs contain stocks that mirror a given stock market index. Teams were expected to invest one-fifth of their index portfolio as follows during the next classes:

§ an all-world ETF so as to learn how to use the simulation’s trading platform,
§ either a broad U.S. market ETF or a broad Canadian market ETF,
§ a sector ETF (such as Tech or Health Care),
§ a country-specific equity ETF (other than Canada or the U.S.),
§ an equity ETF of their choice.

Each team then had a few days to make any changes to their index portfolio, and then they were instructed to leave it alone.

The Active Portfolio

Each team had a second portfolio which also would be jointly controlled. This one, however, would be actively managed. It would be filled with shares of individual companies, and teams would be encouraged to actively trade holdings; this account would be called their active portfolio. We covered financial analysis concepts such as technical analysis (examining stock charts) and fundamental analysis (dividend yield, price-to-earnings ratio, etc.) so that they knew how to compare companies. Again, options were limited in the early days so as not to overwhelm them. The choices were restricted to two Canadian companies in the same sector (such as two Big Banks) on one day, then two U.S. tech giants on the next day, for example.

Let The Trading Begin

Then, the beauty of “Genius Hour” kicked in. Teams could use their active portfolio to buy any stocks that they wished. I also showed them how to use tools to protect profits, such as stop-loss orders and taught them how to short a stock. They were required to track their trades and, more importantly, the thinking behind their trading decisions on a spreadsheet.

Much learning happened over the ensuing weeks. The energy in the classroom was electric as students experienced the ups and downs of the stock market. I shared business articles to generate lists of companies to consider for their active portfolios. It was as realistic as could be, except the accounts weren’t funded with actual dollars.

Lessons Worth Considering

The students and I co-constructed the assessment and evaluation rubric that would be used at the end of the simulation. The goal was to assess each student’s critical thinking and communication skills. What follows is a sampling of student reflections as the simulations wrapped up, along with some lessons to consider.

“Our active portfolio was doing well, and then we got crushed. The index portfolio didn’t go up as much, but it didn’t fall as far either.”

There is a reason why large pension plans rely so heavily on diversification as the key investment strategy over the long term. It’s a great way to mitigate investment risk; index investing is built on this principle.

“I couldn’t invest my real money in the stock market. Even though this was just a game, I was too afraid to lose money.”

We are human, and so it’s no surprise that fear and greed are with us every step of the way when we invest. Understanding your risk tolerance is crucial. Structure your long-term portfolio in such a way that you will sleep at night when (not if) stock markets correct (drop by 10%+) or crash (drop by 20%+). Panic selling is not a good strategy.

“Our worst move was chasing a hot stock. We invested 20% of our active portfolio in a small, volatile stock that was in the news and rallying. We literally bought right at the top and ended up selling when it was down by 50%.”

When you are investing dollars for important long-term goals such as your retirement, avoid any attempts to hit investing home runs. When a stock’s price falls by 50%, it then must rally by 100% to make up for those losses. Having the ability to concentrate is a good thing, but concentration in a portfolio (where too much money is invested in a small number of stocks) increases risk.

“We did a lot of research, but both of our portfolios were still down. We found it stressful.”

Money that you need to access in the next few years should not be invested in stocks. In the short term, stocks can be volatile. Once your investing time horizon is long enough, broad stock market indices have been able to generate returns that beat inflation.

“I could easily see myself using the index strategy with real money when I’m done school. I just don’t think I’d have the time to use the active strategy.”

Time. We never have enough time. Finding the time needed to actively trade stocks in a portfolio is a challenge.

Index Investing Is Here To Stay

Embracing index investing has lots to offer, as my students learned first hand. This is especially true for those who are just beginning to invest so as to reach their long-term financial goals, but it’s equally true for those investors who are more seasoned. Many significant additional benefits, such as lower fees, exist too. As a result, index investing isn’t going away anytime soon, and we’ll explore how to go about index investing next time.

Fred J. Masters, BBA, BEd, PQP, is the author of Lessons on Mastering Money: The Personal Finance Guide for Canadians in their 20s & 30s. He is the President of Masters Money Management Inc. and has given financial wellness presentations to all demographics in Canada, including university students and alumni. He is a retired professional educator, having taught senior financial accounting for decades and is a licensed mortgage agent with Mortgage InGenuity Inc. in Waterloo Region. He can be reached at F.Masters@mastersmoneymanagement.ca. To find out more, visit www.mastersmoneymanagement.ca.

This work contains the author’s opinions and ideas as related to the subject matter. The content is by no means designed to provide any reader with individual financial advice. Note that past performance is not a guarantee of future results when it comes to any specific investment or investment strategy. Always consult a competent financial professional for advice when it comes to making financial decisions. No guarantee is made with respect to the accuracy or completeness of the content.