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.

  7. Modern Portfolio Theory (MPT) : The Precursor of Modern Mutual Funds Selection Theory (MMFST)

    Markowitz Modern Portfolio Theory (MPT) published in 1952 and the Nobel Prize in Economic Sciences awarded to him in 1990 was an important step in the development of portfolio management. It used science to discourage the then prevailing risky buy - hold strategy of a single stock in a portfolio. The introduction of diversification and reduced risk in portfolio management proved a major advance in portfolio management for the next half century.

    However since 1952, the investment markets have seen drastic changes, not the least of which, is the exponential growth of mutual funds from about 100 to currently almost 13,000 and rising. Funds have eclipsed stocks as important components of portfolios. Mutual funds now offer more than 200 million investors the allure of diversification with less risk and greater average investor returns.

    Not exactly.

    Investors were the recipients of diversification with less risk but no improvement in net real return levels.


    Confronted with almost 13,000 funds the investor, planner, and adviser are forced to cope with the data overflow and noise that comes with it. Add to this picture a lack of basic research over the last 50 + years into fund selection, it is no wonder real median investment outcomes are a minus zero sum game.

    It is generally agreed mutual fund portfolios do create diversification and in so doing reduce risk but what has been the net effect on improving returns. Investor returns since Markowitz work in 1952 and since the emergence of mutual funds in the mid -1920’s have remained static.

    What would explain the difference between the S&P 500 Stock Index gross return of 11-12% over the last quarter of a century and average investor gross returns of 7.0% annually? Going from gross to net returns, taxes explain 3.5%, inflation 4.0 - 4.5%, costs/expenses another 2.0% for a total difference of 8.5 - 9.0% annually. If an investor were fortunate enough to select funds whose performance equaled the S&P 500 annual return of 11 - 12%, it would be reduced by 9.5 - 10.0% leaving a net return of 1.0 - 1.5%. The average selection skilled investor would, of course, do worse with a net real return of minus 1.8 % annually.

    The following Table shows the effect of costs/expenses, taxes and inflation on the real net return of various mutual fund investments relative to Certificates of Deposits and their exposures to principal risk:

    The preceding Table shows Certificates of Deposit (CD) and Managed Mutual Funds (MMF) on a real net return basis are essentially a zero sum game at -1.0 % and -1.8%, respectively while Unmanaged Mutual Funds ( UMF) and Modern Theory of Mutual Fund Selections (MTMFS) escape the game’s zero sum consequences with modest to robust real annual net returns of 3.0.% and 8.4%, respectively..

    From a risk/reward point of view, investing in CD’s has less principal risk and greater real net return than MMF, an unprecedented conclusion in view of USD $ 7 trillion invested in MMF funds by investors who are relying on positive net real outcomes for retirement, college education …It also means that even modest investor, planner and adviser return expectations over time have been not been realized. Because of negative real net returns ,the doubling of principal is not possible for MMF, however, UMF and MTMFS would double every 24 and 8-9 years, respectively.

    Our research studies evaluating return and risk (beta) over the entire markets spectrum show the exposure to principal risk between UMF and MTMFS to be essentially the same “low to medium” level - also an unprecedented conclusion.

    In view of the impact of fund selection on zero sum game results, it is vital for investors ,planners and advisers to focus on UMF and beyond to the MTMFS level. The 90% of mutual funds consistently invested in MMF’ s at unfavorable risk/rewards mean 45-50% of all fund investors are at minus zero sum in real terms .

    Since it is impractical to assume loads/costs, taxes and inflation can be drastically reduced some time soon, the use of MTMFS represents an unprecedented opportunity to significantly improve real net returns and prevent the further erosion of investor expectations.

    Arthur Regen
    Managing Director