There’s a unique property of finance and financial assets that many don’t understand. Finance is a zero-sum game. Someone has to lose in order for someone else to win. This is true for all asset types from a purely mathematical standpoint. Let me give an example to demonstrate:
Joe bought a house in 1970 from Martha for $50,000. He lived there for 30 years, and sold the it for $200,000. Joe made a hefty profit by quadrupling his initial investment. But what about Martha? What happened to her $50,000? Maybe she put it under her mattress, which would mean that in the year 2000, she would still have $50,000. Martha missed out on $150,000 of appreciation that Joe was able to capture. Her loss was Joe’s gain. But maybe Martha invested the money in IBM stock and her total portfolio is now worth $500,000. She made a smart trade and outperformed Joe. However, Martha bought the IBM stock from Bob. When Bob sold his IBM stock to Martha, he put the proceeds in a safe money market fund. His money grew to a mere $65,000 by the year 2000. If Bob had held onto his IBM stock, he would’ve made $450,000 on his $50,000 holdings, but instead he only made $15,000. Bob’s loss was Martha’s gain.
The reason that finance is zero-sum is because every transaction involves a buyer and a seller. The two parties perform transactions that are inversions of each other. If I trade stock for cash with you, you’re trading cash for stock with me. We both believe we are doing what is in our respective best interests. I believe my stock has run its course, and so, I’d rather hold cash because I think the stock will drop in value. You believe the stock has upside and that’s why you trade your cash for stock with me.
Both of us can’t be right. One of us will profit and the other will lose.
But this is a very quantitative analysis of market transactions. People generally don’t make financial choices based solely on future projected profits and losses. Most people make decisions based on how they feel. And many people make financial decisions based on the stage of life they are in. If you’re 85 years old, you’re not going to worry as much about your house’s appreciation over the next fifty years, because you’ll be dead by then. What you might consider instead, is converting your house into cash so you can travel and experience the world while you still can. And maybe you sell that house in a down market and get screwed on the price. But what does it matter anyway? You can’t take any of it with you when you go.
[this is a revision of an older post from December 18, 2019]