A zero-sum game is a situation where, if one party wins, another loses by the same margin.
If you think about investing you may believe that buying and selling shares is an example of a zero-sum game – and it can be! However, did you know that not all investing is actually a zero-sum game?
In this article we’re going to explain why this is, and how your investing style can have a big impact on whether you’re involved in an activity where only one party can be triumphant.
Keep on reading for all the details or click on a link to head straight to a section…
What is a zero-sum game?
Tennis, chess, snooker, poker, and even monopoly. All are examples of zero-sum games. That’s because for there to be a winner in these activities, there must also be a loser, or multiple losers.
For a game to be zero-sum, the total amount won by by the winner must be equal to the loss, or combined losses, of the other participant/s. In other words, the net benefit of the game is ‘zero’.
is investing a zero-sum game?
Investing can be a zero-sum game. However, this is only applies to a certain type of investing style – mainly short-term active investing.
Active investing refers to an investing style where investors, or appointed fund managers, pick and choose stocks with the hope of beating average market returns.
In order to ‘beat’ the market with active investing, other investors must lose out by the equivalent amount. To put it another way, if an active investor manages to beat average market returns by 2%, then this gain will have had to have come at the expense of other market participants.
Day trading is an example of a zero-sum game. Say an investor buys a share at one price, and then sells it hours later after its price spikes. This profit will have come out of the pocket of another trader. In other words, there’s no net change.
Likewise, investors who partake in buying contracts for difference (CFDs), or futures trading, are other examples of zero-sum games.
don’t forget about investing fees…
Some would argue that active investing should actually be considered a ‘negative-sum’ game, given there are fees involved in buying shares.
For the sake of this article, however, we’ll park the idea of investing being considered a negative-sum game for now…
why does it matter?
It doesn’t really.
There isn’t anything wrong with the fact that short-term active investing can be a zero-sum game. However if you pick and choose your own stocks to beat the market, employ the services of a fund manager, or decide to day trade, then it’s worth knowing that for you to come out on top, you’re essentially relying on others to lose out.
Remember, when it comes to buying and selling stocks, even the ‘experts’ can find it difficult to beat the market – especially on a consistent basis. And yes, this also applies to those ‘high alpha’ fund managers who claim they can constantly outperform the market. Never lose sight of the fact that the professionals still have to play the same zero-sum game as everybody else.
passive investing: how to escape the zero-sum game
Not all investing is a zero-sum game.
Passive investing refers to buying many slices of individual companies. While this can be done by buying lots of individual shares, it’s more commonly achieved by buying an exchange-traded fund, or index tracker fund. This is mainly because it’s a far cheaper way of gaining exposure to multiple shares.
In brief, a big reason to invest passively is to sit tight, and wait for your investments to rise over time without having to worry about which stocks to buy and sell, or trying to beat the market.
Of course, when it comes to any type of investing there can be bumps or even crashes along the way. Despite this, the stock market does generally head upwards over an extended period of time.
Let’s take a look at how the UK’s two largest share indexes have performed over the past two decades…
In the 20 year period between January 2003 and January 2023, the FTSE 100 increased by 92%. The value of the FTSE 250, meanwhile, has climbed a massive 350% over the same period.
Over the past decade, between January 2013 and 2023, the FTSE 100 has risen 25% while the 250 has soared 52%.
Of course, these share indexes can, and do, fall in value, especially in the short-term. We also haven’t factored in inflation, currency devaluation, or dividends in the above calculations. But the point is, in the long-term at least, the stock market usually ascends.
Why the stock market rises over time
It’s quite easy to explain why the stock market often rises over many years, or even decades.
Over time, companies typically become more efficient, more productive, and more profitable. This might be due to technological advances for example. Multiply this effect across the constituents of the major share indices, and it isn’t difficult to understand why the collective value of companies typically increase as the years pass by.
This collective growth is why investors who buy shares without the intention of beating the market aren’t involved in a zero-sum game.
In other words, when buying stocks for the long-term, it’s possible to profit without another investor taking a hit. This is because your returns are coming from growth, not off the back of an unlucky day trader.
If you wish to learn more about this topic do take a look at our article that explains the differences between passive and active funds.
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Disclaimer: MoneyMagpie is not a licensed financial advisor and therefore information found here including opinions, commentary, suggestions or strategies are for informational, entertainment or educational purposes only. This should not be considered as financial advice. ISA tax treatment may change in future.
*This is not financial or investment advice. Remember to do your own research and speak to a professional advisor before parting with any money.
