Sunday, October 01, 2006

Is investing a zero-sum game?

This is one question that I would like to answer a long time ago but have always thought I don't have a good answer yet. Nevertheless, I shall attempt to answer that today. Is investing a zero-sum game? I think the answer is both yes and no.

BTW, this post is talking about investing in general, which include fixed deposits, bonds, stocks etc, so not just stock alone, ok hor?

The answer is partly yes, it is a zero-sum game, because whatever you buy, you will have to sell to make a real profit (as in not just paper gain), and whoever bought it from you would be deprived from the amount that you profited. So whatever you gained, he would have "lost" (or failed to gain).

However, we must understand that the world's economy has been growing on average 3-5% p.a. for the past 100 yrs and stocks have grown at roughly 10% p.a. while bonds roughly 5% p.a. So in aggregate, investors would have earned roughly 5-8% (Hence this blog is called 8% p.a., in case you haven't realized), depending on their portfolio mix and also assuming that whatever they invested in did not go bankrupt or go into default. (Actually if they diversify, even if some investments become zero, others would have made up for it. So in aggregate their portfolios will still earn a positive return)

So this is to say, even when you sold your stock at a profit to the next guy, he will not necessarily lose money, because in aggregate, everything will grow, at the very least, with the world economy. He will at least earn 3-5%, if he simply buy government bonds, or 10% if he put everything into stocks.

In other words, the "zero" in the zero-sum is actually 3-5% (which is also roughly the global GDP growth rate) and for stocks, the zero is maybe 8-10%, depending which market you invest in. Hence the "no": as in investing is not a zero-sum game, if someone earns money, it does not mean that someone else is losing money.

To conclude, in the game of investing when you make a realized profit, you deprived someone of that profit but if the next person holds it long enough, he will not lose money, because at the very worse, his investment will grow at the same rate with global economy.

See also The Greater Fool Theory
and Markowitz Portfolio Theory


  1. Hi! I call myself Fishman online...I noticed your link through Frank's blog on commodities trading.

    Like your blog. Think it is very interesting, guess because its not fulled with technical jargon. Instead its more on your thoughts on the topic.

    I'm also writing a blog which I call Million Dollars Dream, where I share my thoughts on investment and wealth management. Do drop by and give me your comments!

    Meanwhile, all the best and hope you beat 8 p.a returns! ^_^

  2. Between Dec 1899 to Dec 1999, the Dow went from 65.73 to 11,497 representing a compounded yearly increase of 5.3%. In stock investing, it should be treated the same as how you would in owning a business. In aggregate, the return on stocks can never be more than what a business can churn out in aggregate. We will run into a maths problem if a subset of product can exceeds the aggregate value of the product. Someone once said to Mr Buffett: "In New York, there are more lawyers than people." No doubt some people can invest better than some others but in aggregate, the return can never be more than 5.3% in stock investing for all the investors combined. Those who perform better than 5.3% are those who took more from the same piece of pie at the expense of those who perform less than 5.3%. Moreover, in reality, investors as a whole cannot even hope to match this aggregate (5.3%) that a business earns. This is because in stock investing, there are intermediary where a cut is paid for and all of these cuts are part of the aggregate that the business produces. In other words, in stock investing, it is wrong to assume that all the profits will go to the investors' pocket, part of it (a pretty substantial ratio) goes into the pocket of those who facilitates the trade.

  3. Hi J-chan,
    Nice blog.
    Like economic growth is not a zero sum game, I believe that the stock market growth is not one too. However, there definitely are the winners and the losers as well. We will do well to keep to our principles and philosophies when trading to make the best of the market.
    I agree with Bershire that there is an outflow into intermediaries who are indeed making a killing.
    For a "conspiracy theory" view of the market, please see Bill is a person who has lived thorugh the sell-side of the business and is now championing for the Little People. Bill is generally a good (to great) guy with his heart in the right place. But he is NOT a stock analyst who will recommend any stocks. His views must also be analysed through your own perspectives. Overall great site for views and info.

  4. Hi Berkshire, good point on how intermediaries can suck investors profit, and how much long term return actually works out to be (only 5%, so this blog's title is a bit off I guess).

    And Fishman, hope you make your million dollar, been to your blog, good one, keep it up. Will add a link to it asap.

    And Renxin, thanks for the link, will take a look.

  5. Hi 8percent, I do not think 8% is difficult to achieve over the long run for those investors who are discipline and who have the correct fundamentals. For the 5%, it is meant to be taken as a whole when averaged out. For me, my personal target in compounded return is average 13% for as long as I am in this. 13% don't have to be a constant one year after year. I would rather a bumpy 13% gain than a smooth 8% gain. Some years I bear with negative gain, some years I take alot more.

  6. Thanks 8%! I'll be adding a link to you soon, if you don't mind.

    I too hope to achieve my dream! The thing is with a specific and clear dream, I can strive to make it a reality. Rather than live my day aimlessly.