For every winner in a game of, say, tennis or chess, there’s obviously a loser.
These are zero-sum games. Investing is also sometimes described as a zero-sum game.
Since the market return represents the average return of all investors, for every market-beating investment position, there’s a losing position. In other words, it’s a zero-sum game in a theoretical, cost-free market.
In the real world, however, there are, of course, investment costs. Once investment management fees, transaction costs, buy-sell spreads, taxes and other expenses are taken into account, the percentage of investors with below-index returns can significantly rise.
So, investing in real life is much tougher than a zero-sum game when it comes to the likelihood of producing market-matching or market-beating performance.
The recently-updated Australian edition of a key Vanguard research paper – The case for low-cost index-fund investing – once again takes a close look at the concept of the zero-sum game.
As the authors of this paper write, "the central concept" underlying the case for index-fund investing is that investing is zero-sum game.
"The zero-sum game, combined with the drag of costs on performance and the lack of persistent outperformance creates a high hurdler for active managers in their attempts to outperform the market," they emphasise. (This paper once again documents and updates this lack of persistent outperformance by Australian share funds over the long term.)
Given that investment is conceptionally a zero-sum game – and even tougher once investment costs are counted – how should investors play that game?
Many investors decide the best course for them is to have a low-cost, broad-diversified, index core to their portfolios surrounded by a carefully-chosen of satellites of favoured actively-managed funds.
Whether investing in index funds, actively-managed funds or a combination of both, investors should place a high priority on minimising their costs.
With high costs and inadequate diversification, investing can quickly become a badly losing game.
