Q&A: Zero-Sum Investing?

Q.

Many investors say that investing is a "zero-sum" game and that those who allocate their portfolios in index mutual funds end up with the upper hand. How does this help index investors?

A.

Real investing is not a “zero-sum” game, trading securities is. For every buyer, there is a seller. For every winner, there is a loser. However, investing (by our definition) relies on the steady growth of the global economy (with the occasional setbacks required to make it frightening enough to create that all important risk premium). Investing can be tweaked to provide greater returns by taking more risk of volatility, or an investor can accept lower returns with less extreme variability.

Index (or passive) investing should be compared with active investing. Active money managers believe that they have some system that allows them to do the impossible; predict the future or time the markets. For this perceived skills, they command a fee. This fee means that even if they do manage to duplicate the returns of the market (the economy), they will net less for their investors. 

For active fund investors to come out ahead a manager needs to not just match the market, but exceed it consistently. There is no evidence that they have market-beating talent. Multiple studies have borne this out, including two that found that the few who have managed to beat the market in any given year are more likely to be lucky than skilled.

Investors who look for someone to beat the market are actually beating themselves and making money managers wealthy. Investing is too simple to be this hard. Own the market/economy and let it grow. It turns out that our emotions and behavioral biases make that a lot easier said than done.