Hat tip to Vadas at Abnormal Returns for pointing out this article from Behavioral Investment about why we make stupid investment decisions. 

The article lays out nine reasons why normally rational, thoughtful people make what he describes as "sub-optimal" investment decisions. As I read through the list, I realized how our investing game STAX (over 160,000 game plays since November launch) gives students an opportunity to make a lot of stupid decisions which they hopefully will learn from and avoid making in the "real world." 

Let me explain how several of these factors that lead to stupid decisions are baked into the mechanics of STAX:

• We make decisions outside our circle of competence. What makes a student think that they can pick individual stocks or commodities or gold or time the markets while playing STAX? They are given minimal information about the various asset classes and are making decisions solely based on....you will have to ask them! 
• Stress. Watch a classroom playing STAX and you will see stress level rise as they try to adjust to the ever-changing financial markets. Making 20 years of investment decisions in 20 minutes with at least one significant (and maybe two) market collapses might just lead to examples of "buying high" and "selling low" as stress takes over the rational part of the brain. 
• Rushing or urgency. STAX encourages players to invest their Pocket Cash in a timely fashion which certainly can feed into this sense of urgency. Who has time to think when every 30 seconds, you're getting new money to invest? 
• Information overload. Play 5 minutes of STAX and you will experience this phenomenon. What should you be tracking? Why did gold just drop 15%? Why is that pig talking to me? How much Pocket Cash do I have? Why did a tree just crash through my house? The best way to describe the game mechanics..overwhelming to adults, engaging to students:)
• Overconfidence/ego. If you share the Leaderboard with your students, there will likely be one to a few students who might pull ahead early as they take their chances on the volatile individual stocks. As they see their lead increase, they might even double down on their strategy and make concentrated bets on only one or two investments. It's quite rare for that strategy to succeed for the entirety of the game. Why? When the markets start moving against their investment, they have trouble letting go of ego and overconfidence and tend to hold onto the positions for too long (Bill Miller is example of this in the investing world). 
• Group/social cohesion. Display the STAX Leaderboard in the middle of the game and suddenly everyone starts asking "Hey, what's Jane doing that's putting her in first place?" They start to make decisions based on what others are doing and many will make riskier bets in hopes of climbing the board. Unfortunately, this type of behavior translates in the real world as strong performance with a given asset can lead to bubbles forming with bitcoin being a recent example. 

Be sure that your post-STAX discussion includes these factors so students will learn not to repeat these "stupid" decisions when they start investing. 

About the Author

Tim Ranzetta

Tim's saving habits started at seven when a neighbor with a broken hip gave him a dog walking job. Her recovery, which took almost a year, resulted in Tim getting to know the bank tellers quite well (and accumulating a savings account balance of over $300!). His recent entrepreneurial adventures have included driving a shredding truck, analyzing executive compensation packages for Fortune 500 companies and helping families make better college financing decisions. After volunteering in 2010 to create and teach a personal finance program at Eastside College Prep in East Palo Alto, Tim saw firsthand the impact of an engaging and activity-based curriculum, which inspired him to start a new non-profit, Next Gen Personal Finance.

More posts by Tim