A zero-sum game is a game in which the magnitude of one player’s success will be equal to the magnitude of another player or players’ failures. For example, when you play Texas Hold ‘Em with your four buddies, every dollar that goes into every pot came from somebody’s wallet. At the end of the night, there is no way for all five players to go home winners. Every dollar that one player wins is a dollar that another player loses. So is the stock market a zero-sum game?
The answer is… not exactly. If you make some assumptions about the market, you can think of it as a zero sum game. However, the list of assumptions is extremely long. In order for the stock market to be a true zero-sum situation, you would have to assume all of the following: the economies involved do not shrink or grow, the amount of money investors keep in the market does not fluctuate, the total earnings and overall P/E ratio of the market remains the same, and the number of public companies does not change. I’m sure there are other assumptions you would have to make, but those are big enough assumptions for you to see that the answer to the question is no, the market is not a zero-sum game.
As the U.S. economy grows, companies make more and more money, and the earnings of successful companies grow right along with it. During different times in the investor sentiment cycle, traders have different amounts of money invested in the market. New companies are constantly springing up, and poor companies are going bankrupt every day.
Take a look at an inflation-adjusted 100-year chart of the Dow Jones Industrial Average:
Now look at an inflation-adjusted chart of the U.S. GDP:
Yeah, the size of the U.S. economy is far from fixed, and the stock market has actually created wealth for investors over time. I encourage anyone to invest in the stock market as long as you believe that the U.S. economy will continue to grow in the future.
So there you have it: the stock market is not a zero-sum game. But tomorrow I will talk about an aspect of the market that is a zero-sum game and why it’s not as hard as you may think to come out a winner in the game!
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