Financial myths which are untrue

[f97tosc]

#1. Agreed.

#2. Sort of disagree. I think virtually everyone agrees that it is possible in theory to beat the market; the question is just whether it is reasonable for an average smart person with reasonable time and information to do this, especially after considering potentially higher fees and taxes. To use your poker analogy, if you didn’t know how poker worked and just observed the chips move for a while, how would you determine if it was a game of skill or luck? Just the fact that some people did better is not proof; this would happen at a Roulette table as well. Even after many days some would do well for both poker and Roulette. One nice test would be to take the winners one day, and see if they on average did better the next day. Interestingly, when this is test is performed on for example on actively managed funds or by newspapers asking leading analysts, there tends to be no correlation between past and future performance, as for the Roulette table.

#3 Agree with qualification. The (secondary) stock market is a fixed sum game, specifically over future dividends, which are fixed as far as most investors are concerned. Sometimes when people say zero sum game they really mean fixed sum game. The point is that you can’t make everybody better off by publishing a great investment book. If your readers gain some, others will lose the same.

[Newt_Buggs]

1. This is assuming a zero risk account, but what about investing in the market for the long run? Sure 5% of a million isn't very much after taxes and inflation, but what about 10% from the market if you are invested for the long run and don't mind some swings?

2. I'm way out of league here, but I suspect that it is pretty absurd for non professional investors to buy anything other than funds unless you derive personal enjoyment out of selecting stocks and don't mind if the effort is yielding nothing. The chance that a more casual investor can accomplish what most professionals fail at (beating the market) makes me believe that the time required and the small chance of success means that anyone who isn't a very talented expert investor would be better off with funds.

3. Some others have briefly addressed this I believe with a constant sum game. If I overperform the market then that means someone else had to underperform the market. Eg: If the market returned 10% and I pulled a 12% return on 1 mil, then that means another investor(s) had to only return 8% on 1 mil.

edit: perhaps my #3 is slightly incorrect because good stock picks lead to a more efficient allocation of resources?

Now someone who knows a lot more than me needs to show me where I'm wrong.

[Checkraize]

Plenty of people beat the market with regularity their just the ones you don't hear about because they are not in your face, they are quietly making money through all the hype.

[Jeff W]

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I don't think that randomness in payouts precludes it from being a constant sum game. Poker is a constant sum game(zero sum if there is no rake) even though the payouts are probabilistic. What I mean specifically by constant sum is that the sum of the payoffs for all players is the same for all strategies. Regardless, I don't think the stock market is a constant sum game, but I'm interested if there is an argument to that effect as I'm ignorant of economics.

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it's not a constant sum game. innovation doesn't occur at a constant rate.

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I guess I'm not articulating well enough. Is the trading of stocks a constant sum game--is one trader's gain above the average return a loss for the rest of the traders in the market?

[DesertCat]

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#3 Agree with qualification. The (secondary) stock market is a fixed sum game, specifically over future dividends, which are fixed as far as most investors are concerned. Sometimes when people say zero sum game they really mean fixed sum game. The point is that you can’t make everybody better off by publishing a great investment book. If your readers gain some, others will lose the same.

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You can argue that John Bogle made everyone better off, because he promoted Index Funds and long term investing, which reduces transaction costs and allows more of the market returns to accrue to investors, instead of being sucked up by transaction and management costs.

And even for active traders, the end of fixed commissions and wall street competition has lead to lower transaction costs.

And the stock market isn't a closed system. If I buy your shares from you at a price low enough to ensure an above market return for myself, you might invest the proceeds in an even higher return investment opportunity outside the stock market (real estate, commodities, your own porno web site).

Even if you broaden the definition of the market to encompass all possible investments, there are still two reasons why it isn't a fixed sum game. First is that the person who sold their shares may, instead of reinvesting the proceeds, instead consume it and create more utility through consumption than a higher return investment would have provided (hookers, blow, high stakes craps games). So utility isn't fixed.

And returns aren't fixed either. Assume when you sold your stocks instead of reinvesting proceeds the all encompassing market of investments, but instead bought a tricked out hummer (consumption). You take the fully equipped hummer out into the woods and after an extensive search, locate a gold mine, which you then use the remaining stock sale proceeds to develop, creating massive new wealth far in excess of the returns available in the existing market.

The value of the market is based on the future stream of earnings (not dividends which are subset of earnings) of it's components. The size of future streams of earnings are dependent on how effectively todays earnings are reinvested. The efficiency of that reinvestment is driven my many factors, government regulations and tax laws, consumption vs investment ratios, natural resources available, technology levels, the creativity of entrepeneurs, etc.

[Cubswin]

Myth #4 Credit cards are bad.

Myth #5 I should close credit card accounts I do not use.

Myth #6 Having too many credit cards is bad for your FICO score.

Myth #7 Owning a home is always better than renting.

[pig4bill]

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2. I'm way out of league here, but I suspect that it is pretty absurd for non professional investors to buy anything other than funds unless you derive personal enjoyment out of selecting stocks and don't mind if the effort is yielding nothing. The chance that a more casual investor can accomplish what most professionals fail at (beating the market) makes me believe that the time required and the small chance of success means that anyone who isn't a very talented expert investor would be better off with funds.

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Now there's a myth if I ever heard one.

[Sniper]

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3. Some others have briefly addressed this I believe with a constant sum game. If I overperform the market then that means someone else had to underperform the market. Eg: If the market returned 10% and I pulled a 12% return on 1 mil, then that means another investor(s) had to only return 8% on 1 mil.

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This is wrong on many levels...

[SlowHabit]

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If I buy your shares from you at a price low enough to ensure an above market return for myself, you might invest the proceeds in an even higher return investment opportunity outside the stock market (real estate, commodities, your own porno web site).

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Veiled fantasy? [img]/images/graemlins/cool.gif[/img]

[stinkypete]

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I don't think that randomness in payouts precludes it from being a constant sum game. Poker is a constant sum game(zero sum if there is no rake) even though the payouts are probabilistic. What I mean specifically by constant sum is that the sum of the payoffs for all players is the same for all strategies. Regardless, I don't think the stock market is a constant sum game, but I'm interested if there is an argument to that effect as I'm ignorant of economics.

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it's not a constant sum game. innovation doesn't occur at a constant rate.

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I guess I'm not articulating well enough. Is the trading of stocks a constant sum game--is one trader's gain above the average return a loss for the rest of the traders in the market?

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yes