Is the stock market a zero sum game?
The answer depends on how we decide to participate in the stock market.
The stock market is not a zero sum game when investing over the long term. However, the stock market is a zero sum game when engaging in short term speculative trading (options, etc.).
For this to make more sense, we first need to understand what a zero sum game is.
What is a Zero Sum Game?
A zero sum game is a situation where one person’s gain is equivalent to another person’s loss.
In other words, there is always a clear winner and loser (one gains only because one loses).
The best real world example of a zero sum game is flipping a coin.
When flipping a coin, there are only two outcomes that can occur: you can either win or lose.
- If you win, then the other person loses (1-0)
- If you lose, then the other person wins (0-1)
If you sum the wins (+1) of one person with the losses (-1) of the other person, you will get zero.
Other real world examples of zero sum games include:
- Checkers
- Poker
- Chess*
*When playing chess, you can either win or lose. However, it’s not a pure zero sum game due to the ability to end in a stalemate (no one wins or loses).
Now that we have defined what a zero sum game is, let’s transition to see how this concept applies to the stock market.
When the Stock Market is not a Zero Sum Game
Investing in Individual Companies
The stock market is not a zero sum game when investing over the long term.
Think about it this way.
Let’s imagine that Company X is wanting to raise money in order to fund a new product line.
To finance this project, Company X decides to sell 10 shares of company stock to 10 investors (1 share / investor) @ $10 / share.
With the money in hand, Company X launches the new product line and it ends up being a huge success. Due to the successful product launch, the company’s stock is now worth $15 / share.
Each and every individual investor benefited from this product launch. There were no investors who lost $5 and others who made $5. Everyone made $5 / share.
In other words, it was a win-win situation for everybody involved (not a zero sum).
We don’t just give free money to companies in exchange for nothing. In that case, it would be a zero sum game because the company is making money and we are losing money by not getting anything in return.
Instead, we are investing our money in exchange for ownership in the company. The intent being that they will then use that money in order to grow the company resulting in our money (shares) being worth more.
Investing in ETFs & Mutual Funds
OK, so what about investing in ETFs & mutual funds vs. individual companies?
The stock market is still not a zero sum game.
As an example, imagine that in 2010 you invested in a few mutual funds to create a three fund portfolio.
Let’s say one of those funds was VTIAX.
As of this writing, VTIAX has had a total cumulative return of 56.98% since 2010.
That 56.98% return is a direct result of the aggregated performance of the companies held in that fund. Additionally speaking, that 56.98% return didn’t happen because someone investing in the exact same fund at the exact same time lost 56.98%. See how silly that sounds?
Said another way, if long term investing in the stock market was truly a zero sum game, then the average return of all funds would be 0% because for every gain there would have to be an equivalent loss. That is simply not true.
When the Stock Market is a Zero Sum Game
Speculative Trading
The stock market becomes a zero sum game when engaging in short term speculative trading.
To illustrate this point, let’s discuss options contracts.
In a nutshell, an options contract is a type of investment that gives someone the ‘option’ to buy or sell a financial security (such as stocks) within a specified period of time. There are two types of options contracts:
- Call Option – Contract giving someone the right to buy a financial security for a specific price within a specified period of time
- Put Option – Contract giving someone the right to sell a financial security for a specific price within a specified period of time
However, options contracts do not represent direct investments into companies. According to Investopedia, they instead represent an “agreement between two parties [not the company] and, if one investor loses, then the wealth is transferred to another investor.”
It’s important to note that options contracts essentially boil down to betting whether or not the price of an asset is going to go up or down (sounds a lot like a coin flip).
In other words, there is a clear winner and loser in these types of stock market transactions.
Final Thoughts
When I first started investing in the stock market, I used to think it was all a zero sum game.
When I logged into my brokerage account I saw a “Buy” button and a “Sell” button. With only two options available, there always had to be a clear winner and loser, right?
Not necessarily.
The stock market is a complicated web of different players and financial assets. Sometimes it is a game of checkers where there is a clear winner and loser. Other times it is a game where everybody participating can win or lose. It honestly depends on how we decide to participate.
Thank you for reading! 🙂
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