Growing up, I was the oldest of six kids. To help put food on the table, we raised a garden each year and fed out a hog or a calf to put in the freezer.
The corral where the animal was kept was about seventy yards from the house and we had to carry feed and water to it each day. One day, several of us kids were arguing about whose turn it was to feed the calf.
Finally, Mom had had enough of the bickering. “I’ll just go feed him myself,” she said. “But keep in mind that the good Lord only gave me so many steps on this earth. And when I’ve used them up, I’ve used them up!” Of course, at that point, I had visions of Mom dropping dead in the feed lot, having used up the last of her allotted steps. So, being the oldest, I immediately agreed to go feed the calf.
Years later it dawned on me that if the Lord had given Mom a finite number of steps, He had also done the same for me. And while I might have been saving Mom some of her steps, I was using up some of mine!
What I have described above is sometimes referred to as a zero-sum game. In other words, one person gains (Mom’s steps being conserved) while another person loses (my steps being depleted). Suppose Mom baked a pie that night to reward me for doing what was my job anyway. And she let me divide the pie among the six kids. If I cut myself a bigger slice, my siblings end up with less. My gain is at the expense of their loss. The pie is fixed in size. This is another example of a zero-sum situation.
From time to time I run across folks who view the stock market as a zero-sum game. The argument goes something like this: “I’m thinking about buying a stock because I think it is going to go up in price. But the person selling the stock thinks it’s going down in price. We can’t both be right. So, one of us is going to win and the other is going to lose.”
Well, let’s dig into that argument a bit. For starters, the fact that a person is willing to sell the stock doesn’t necessarily mean they think it’s going down in price. Maybe they just need cash to buy something like groceries, or a yacht, or something in between. Perhaps they have made a nice profit on the stock and are ready to cash out, regardless of any future expectations of price movement.
As an example, assume the potential seller in this case had bought the stock at $25 a share. The stock is currently trading at $40, and the seller likes the fact that they have a profit of $15.
You have been watching the same stock and decided that $40 is a reasonable price. You actually expect the stock to move higher over time, perhaps to $60 eventually. So, you go ahead and buy the stock at $40. And sure enough, the stock does hit $60 the following year. Happy with that $20 gain, you sell out.
Note that both owners of the stock made a profit. There are no losers in this example.
Going back to the pie example, the stock market is not a pie that is fixed in size. Rather it is a pie that has historically gotten bigger and bigger over time. But you should also be aware that the stock market pie can shrink in size, meaning that you lose money instead of making money. Those “shrinking pie” periods are known as market corrections, and they can be nerve racking. So, invest with caution and don’t take on more risk than you can stand. By the way, I’m happy to report that Mom still hasn’t used up all of her steps!
Dr. David Ashby is a Certified Financial Planner and the retired Peoples Bank Professor of Finance at Southern Arkansas University. He holds degrees in accounting and business administration and a doctorate in finance from Louisiana Tech.