Is the stock market a zero-sum game?

Question

In the stock market, over both the short and long-term, does someone necessary need to lose in order for someone else to make a profit? If not, then more fundamentally does something — in the most abstract sense — need to lose value in order for another's investments to gain value?

Is the stock market a zero-sum game?

Note: Thus far I've received a few answers basically explaining that companies can increase in value spontaneously from increased consumer confidence, but in a far broader sense doesn't this result in decreases elsewhere in the system? I'm really looking for a technical explanation of why the stock market is or isn't a zero-sum game.

Answer 1

Would you mind adding where that additional value comes from, if not from the losses of other investors?

You asked this in a comment, but it seems to be the key to the confusion.

Corporations generate money (profits, paid as dividends) from sales. Sales trade products for money. The creation of the product creates value. A car is worth more than General Motors pays for its components and inputs, even including labor and overhead as inputs. That's what profit is: added value. The dividend is the return that the stock owner gets for owning the stock.

This can be a bit confusing in the sense that some stocks don't pay dividends. The theory is that the stock price is still based on the future dividends (or the liquidation price, which you could also consider a type of dividend). But the current price is mostly based on the likelihood that the stock price will increase rather than any expected dividends during ownership of the stock.

A comment calls out the example of Berkshire Hathaway. Berkshire Hathaway is a weird case. It operates more like a mutual fund than a company. As such, investors prefer that it reinvest its money rather than pay a dividend. If investors want money from it, they sell shares to other investors. But that still isn't really a zero sum game, as the stock increases in value over time.

There are other stocks that don't pay dividends. For example, Digital Equipment Corporation went through its entire existence without ever paying a dividend. It merged with Compaq, paying investors for owning the stock.

Overall, you can see this in that the stock market goes up on average. It might have a few losing years, but pick a long enough time frame, and the market will increase during it. If you sell a stock today, it's because you value the money more than the stock. If it goes up tomorrow, that's the buyer's good luck. If it goes down, the buyer's bad luck. But it shouldn't matter to you. You wanted money for something. You received the money.

The increase in the stock market overall is an increase in value. It is completely unrelated to trading losses. Over time, trading gains outweigh trading losses for investors as a group. Individual investors may depart from that, but the overall gain is added value.

If the only way to make gains in the stock market was for someone else to take a loss, then the stock market wouldn't be able to go up. To view it as a zero sum game, we have to ignore the stocks themselves. Then each transaction is a payment (loss) for one party and a receipt (gain) for the other. But the stocks themselves do have value other than what we pay for them. The net present value of of future payments (dividends, buyouts, etc.) has an intrinsic worth. It's a risky worth. Some stocks will turn out to be worthless, but on average the gains outweigh the losses.

Answer 2

No, the stock market and investing in general is not a zero sum game. Some types of trades are zero sum because of the nature of the trade.

But someone isn't necessarily losing when you gain in the sale of a stock or other security.

I'm not going to type out a technical thesis for your question. But the main failure of the idea that investing is zero sum is the fact the a company does not participate in the transacting of its stock in the secondary market nor does it set the price.

• XYZ Company has a new stock issue.
• Bob and other investors buy the shares from XYZ Company. The company receives the proceeds.
• Bob sells his shares in XYZ Company to Jenny. Bob receives the proceeds.
• Jenny is not at a loss because she received the shares.

This is materially different from the trading of options contracts. Options contracts are the trading of risk, one side of the contract wins and one side of the contract loses.

If you want to run down the economic theory that if Jenny bought her shares from Bob someone else is missing out on Jenny's money you're free to do that. But that would mean that literally every transaction in the entire economy is part of a zero sum game (and really misses the definition of zero sum game).

Poker is a zero sum game. All players bet in to the game in equal amounts, one player takes all the money. And hell, I've played poker and lost but still sometimes feel that received value in the form of entertainment.

Answer 3

The game is not zero sum. When a friend and I chop down a tree, and build a house from it, the house has value, far greater than the value of a standing tree. Our labor has turned into something of value.

In theory, a company starts from an idea, and offers either a good or service to create value. There are scams that make it seem like a Vegas casino. There are times a stock will trade for well above what it should. When I buy the S&P index at a fair price for 1000 (through an etf or fund) and years later it's 1400, the gain isn't out of someone else's pocket, else the amount of wealth in the world would be fixed and that's not the case.

To be fair, there are bits of the market that are, in fact, zero-sum. The options market, for example. Options can be used conservatively, e.g. selling a covered call, which lowers the stock owner risk, or it can be the buying and selling of naked options. When a call spread and pay $1000, but see a return of $10,000, there is someone, or likely multiple someone's that lost that exact amount. Likewise, when my trade goes bust, that $1000 goes to the counterparty.

In the early '30s, real GDP was under $1T, Today (2018) it was over $18.5T and the value of one company (Apple) is just shy of $1T.

Even after we adjust for inflation, the long term trend is that cumulative wealth has been increasing over time, not just shifting around.

On the other hand, don't confuse any of this with market saturation. As cell phones started to be introduced, I was in a sales meeting that was discussing electronic components. The forecast for units (of cell phones) went out decades in an exponential growth curve which lost all reason as 2030 showed annual sales of over 10B units per year. It was, and still is, tough to imagine sales growing to over 1 unit per year for every human on the planet. In fact, 2018 saw 1.41B units sold down from 2017. But, these companies are diversified. Apple iPhone units may level out, but the next invention (Apple electric car?) will help continue the growth. Any specific market can saturate, where unit growth is flat and companies just share market, but this is no different than any time in history, total wealth continues to expand.

Answer 4

No.

Share are equity in companies that usually have revenue streams and/or potential for creating them. That revenue can be used to pay out dividends to the shareholders or to grow the company and increase its value.

Most companies get their revenue from their customers, and customers rarely give their money to a company without getting some good or service in exchange.

Answer 5

While this seems overall a macroeconomics question and not really personal finance, let me give it a shot:

The question of why corporations form in a free or efficient market is why Ronald Coase received the 1991 Nobel Prize in Economics, for his work developing the theory of the firm

Corporations organize when there are transaction costs in the free market; corporations form when it is in fact more efficient for a corporation to exist than a number of small producers contracting with one another. To the extent that corporations add efficiency to a total market, they are not "zero sum" at all; the net production is increased over what would exist in a market of sole proprietors who would have costs (such as researching the trust levels in counterparts, regulatory compliance, etc) that they cannot bear to engage in the same level of transactions.

Answer 6

The other answers are correct but I'd like to address why some people say that it is a zero-sum game. It happens when people confuse trading/speculation with investing.

In trading, the focus is on transactions. In that case, it is a zero-sum game. At a given point in time, every transaction has a "winner" and a "loser". If the company is overvalued, the seller is getting more money than he should while the buyer is paying more that he should for the stock. If the stock is undervalued, it's the opposite.

However, this does not take into account the increase in value from holding the stocks. It is a very short-term vision.

As a buy-and-hold investor, you might be a "loser" when you buy your stocks, but you are not focused on the transaction. You will be a winner if/when the stock increases in value.

By dollar-cost-averaging, the objective is that you purchase stocks regularly. Transaction-wise, you will sometimes be the winner, sometimes the loser, and they will average out.

Answer 7

Suppose everybody stopped all economic activity right now. No more work for others, no payments, no trade in kind or otherwise.

Would average wealth stay the same? Of course not. Economic activity is not a zero sum game.

Most of our economic activity is organized in the form of companies. If the companies manage to make more profits by doing useful things more efficiently, or when they find new useful things to do for profit, then not only the company's value grows but also the sum total of all useful things produced in the economy. That means it's not zero sum.

When stock prices go up, that is often because the companies really have become more valueable.

Answer 8

I think the other answers (some very good) have failed to address the actual issue. Why is it not a zero-sum game ?

The answer is that the stock price is completely detached from the people who have bought or sold the stock. If the company reports strong earnings then the share price (should !) goes up. That means that everyone who currently holds the shares now has an increase in value. It is irrelevant whether or not someone actually lost money.

Example:
100 people buy share A for $10 each. Now 1 of them sells their share for $11, suddenly 100 people own $11 in stock A. Literally everyone in this scenario has made money.

Similarly, there was a stock crash in 2008 and I can guarantee that more people have lost money than have made money that year. The total amount of wealth that has "disappeared" is in the trillions. No one received that money. Stocks were just worth less the next day than they were the previous day without anyone making a profit.

Answer 9

No, investing in stock market is not a zero sum game, but quickly speculating in stocks may be (it also may be a negative-sum game).

Investing in gold (as opposed to gold mine), or stashed-away art (that is not displayed in any commercial revenue-generating museum), or properties that are not offered for rent, or bitcoin is a zero sum game.

Investing in stocks, bonds, forest or rental real estate is not a zero sum game. The reasons are simple:

• Stocks pay dividend. Not only that, but with the nominal growth of the economy (including inflation), consisting of growth of individual companies, the dividend grows over time.
• Bonds pay interest. Ok, the interest doesn't grow over time, so bonds are not inflation-protected but they genuinely pay interest so it's not a zero-sum game.
• Forest grows. With the increasing temperatures, and increasing CO2 concentartion in the atmosphere, the growth accelerates.
• Properties pay rent. Ok, properties degrade too and require maintenance, but in most market situations you can pay the maintenance from rent and still have profit.

Actually, you should consider costs of investing too. They can make a zero-sum game into a negative-sum game (if you don't consider the broker as part of the game), and even a positive-sum game into a zero-sum game or a negative-sum game.

So, to ensure you are not going to take part in a zero-sum game or a negative-sum game, don't quickly trade stocks. Instead, purchase stocks and hold them for the long run.

When asking whether something is a zero-sum game, ask yourself the following: is there any inherent return mechanism in the claimed investment? The return mechanism may be growth of a sellable valuable material (forest). It may be interest. It may be dividend. It may be rent. But, there must be a return mechanism for something to be a positive-sum game.