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Predictably Irrational Behavior

Our stock market experiment results are in. The experiment began with the introduction of a single-stock market. We offered one stock – called FOO – an imaginary up-and-coming tech company.

Articles by Betterment Editors

By the Editorial Staff
Betterment Resource Center  |  Published: August 18, 2011

The rules

– Everyone starts with $2,000 and 10 shares of FOO.

–  FOO produces (randomly generated) dividends between $0 and $20 each round, averaging $10 per round.

–  With a total of 15 rounds, a share should be worth $150 (15 rounds x $10).

–  As the experiment continues, the stock should be worth less and less – $140 at round 2, $130 at round 3, and $0 at the end.

The game

Round 1 started off slowly, with shares being sold at prices well below their value (Kiran freaked out and sold a share worth $150 for only $18) but as the rounds progressed, the value of the shares began to grow.

By round 3, FOO reached its peak price of $121 per share, just as people began to realize what it was really worth. Those who understood attempted to buy the shares for slightly less than their value, in the hopes that unprepared employees (a.k.a. the software coders) would allow them to buy low and collect the dividends.

Once the trend shifted to buying, share prices rose above their expected value. This is the type of irrational behavior that would normally create a bubble – who pays $95 for a share worth $70?!

The Betterment team, however, was too smart (or too flustered – take your pick) to let the bubble grow.  Share prices gradually returned to their expected value, avoiding the “pop” (rapid decrease in price) one usually associates with a bubble.

The results

While some lost money, and some gained, one thing became clear: no matter how smart you think you are, trying to out-smart the market is near impossible. People are predictably irrational. It’s better to set it and forget it.

No surprises that our CEO Jon Stein won the game, with a neat total of $4398.

The above results come from an in-office experiment conducted by Betterment intern Sarah Brock. Thanks Sarah!

 

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