Is investing really like gambling?

[Slava]

You can read my latest here: http://victorlough.com/blog/1918775-Is-investing-really-like-gambling

When people think of gambling in a broad sense I assume they equate the risk and reward to things like a roulette wheel, or slot machine, or maybe in less times the lottery. Those are not good proxies for the stock market, and have almost no relation to investing. But when you look at gambling and in particular Poker, you have a much higher correlation with investing and the stock market and here's why:

[GGG]

1. There is a finite amount of money. When you make money in the stock market, someone else is losing. It might not feel this way, but that's the way it is. Same goes for poker. You sit around the table and if you win a big pot against your opponents, someone else contributed to that big pot.



Isn't this point fundamentally wrong. For longs and shorts fine but the entire stock market is based on economic growth giving the player the edge instead of the house.

I disagree with your general premise entirely. In poker some players are better than random distribution of luck would indicate. The same can't be said in investing.

[Slava]

Isn't this point fundamentally wrong. For longs and shorts fine but the entire stock market is based on economic growth giving the player the edge instead of the house.

I disagree with your general premise entirely. In poker some players are better than random distribution of luck would indicate. The same can't be said in investing.

First of all, thank you for reading and posting something!

To your first point, I'm not sure I understand what you mean? I do agree that the stock market is based on growth, but the gains an investor makes are still at someone's expense. It doesn't necessarily feel like that, but it is the way it works.

As far as the general premise, that is a whole other discussion (and one that I would love to have to be entirely honest!), but I do believe that there are investors who do better than luck. There is a book about the luck vs. skill spectrum which goes through investing as well as a number of sports and other areas that is quite fascinating. Its an easy read written by Michael Mauboussin and his premise is that he thinks a lot of things, including investing are a combination of skill and luck. http://www.amazon.ca/The-Success-Equation-Untangling-Investing/dp/1422184234

I don't know how far you want to get into the whole discussion here about whether investors can do better than random luck. I will just say that even the passive strategies that are more in vogue today require a lot of decision making for the investor. Because of that a lot of factors like investor psychology and their assessment of risk comes into play.

[ranchlandsselling]

First of all, thank you for reading and posting something!

To your first point, I'm not sure I understand what you mean? I do agree that the stock market is based on growth, but the gains an investor makes are still at someone's expense. It doesn't necessarily feel like that, but it is the way it .

I'd also disagree with this point. Let's say I invest $1.00 per share in an exploration company whether by private placement or simply buying the shares in the open market. Company uses funds from private placement to drill and discovers something of economic value, produces it, sells it, increases earnings and the value* of my $1.00 share goes up. Or alternatively having bought the $1.00 share on the open market I simply take part in the upside sell and move on.

*Ignoring the dilution aspect of a private placement and assuming the money raised/spent increased value more than dilution.

In both instances no one has lost. The actions of the company have increased value for everyone. Someone may have sold me the share at $1.00 had I not participated in the private placement but they could have bought the share at $0.75 and profited.

[Slava]

Well that's right, but it's only half of the equation. For you to "take part in the upside sell" you have to sell your shares to someone else. In other words you have someone else to buy those shares for say $1.25. I suppose that this is a bit abstract, but economically there is only so much money in circulation in an economy at any one time. So for you to gain that $0.25 means it is coming from somewhere, and someone else is losing that $0.25 for it to end up in your pocket here.

[ranchlandsselling]

Well that's right, but it's only half of the equation. For you to "take part in the upside sell" you have to sell your shares to someone else. In other words you have someone else to buy those shares for say $1.25. I suppose that this is a bit abstract, but economically there is only so much money in circulation in an economy at any one time. So for you to gain that $0.25 means it is coming from somewhere, and someone else is losing that $0.25 for it to end up in your pocket here.

No it's not.
The gain is from growth. That's generally how the economy works. No one lost $25 cents. Just like when the bank writes a mortgage or sells any lending product. I take that money and do what I please with it (could be positive, could be negative) the bank then earns interest on that money. Same with the deposit of funds, I deposit, early paltry interest on the deposit, the bank can go out and lend a greater amount of money using my deposit as a reserve allowance.

In the stock/equity example I sell at $1.25 to someone else who may sell for $1.50 down the line. There's doesn't always have to be a loser.

You're making the assumption that the second or third buyer is going to be a new loser. Which isn't necessarily true.

[Slava]

Investing is a zero sum game though; there is no money that magically appears from thin air, and if you agree that its finite to being with, there is a winner and loser. So if there is $100 in the whole economy and you invest $1.00, when you later get $1.25 for that same share that means someone somewhere has last that $0.25. Its not possible that you just grew the extra $0.25 and no one else lost. It might appear that way, and I understand how an individual investor would see the market that way, but like I say, its zero sum.

[Jason14h]

Investing is a zero sum game though; there is no money that magically appears from thin air.


What about dividends?

[Slava]

What about dividends?

Dividends are a percentage of profits. So that money is already in the economy and already circulating. Someone has spent that money somewhere for the company to gain it and distribute it (in the common sense of dividends, and not companies using other methods to maintain them).

[ranchlandsselling]

http://www.investopedia.com/terms/z/zero-sumgame.asp

DEFINITION of 'Zero-Sum Game'
Zero-sum is a situation in game theory in which one person’s gain is equivalent to another’s loss, so the net change in wealth or benefit is zero. A zero-sum game may have as few as two players, or millions of participants.

Zero-sum games are found in game theory, but are less common than non-zero sum games. Poker and gambling are popular examples of zero-sum games since the sum of the amounts won by some players equals the combined losses of the others. Games like chess and tennis, where there is one winner and one loser, are also zero-sum games. In the financial markets, options and futures are examples of zero-sum games, excluding transaction costs. For every person who gains on a contract, there is a counter-party who loses.

Most of the money in our economy is created by banks, in the form of bank deposits – the numbers that appear in your account. Banks create new money whenever they make loans. 97% of the money in the economy today is created by banks, whilst just 3% is created by the government. This short video explains:

http://positivemoney.org/how-money-works/how-banks-create-money/



It simply isn't a zero sum game. If I raise capital (borrow from banks, investors etc.) a lot of that money comes from credit. It is then grown by my company which may then be purchased for more. Let's say Suncor buys my company with cash that they've profited from a similar exploration, discovery, production process.

Or, let's say I use my $5.0 million raised to find a gold mine and sell to goldcorp for $50 million. All the investors earned $10 for every $1.0 invested. They pay back their credit facilities and wealth has been created. Gold corp has done the same thing. They didn't simply go into debt by $50 million whether they used a credit facility or not.

[Bring_Back_Shantz]

Dividends are a percentage of profits. So that money is already in the economy and already circulating. Someone has spent that money somewhere for the company to gain it and distribute it (in the common sense of dividends, and not companies using other methods to maintain them).

That's simply not true.
Companies and economies grow by creating value.
If I take $100 and use it to dig a hole and find $1000 worth of gold I've added $900 worth of value to the economy.

If I created a company with 10 investors, who each put in $10 then they all sold their shares for $20, they've all made $10. Now I find the gold and divide it up equally between the current stock holders and dissolved the company they've each gained $80, and no one has lost a thing. It's not a zero sum game.

If what you're saying is true, then neither the economy, nor the stock markets could never grow, which is plainly false.

[Slava]

This is really interesting discussion and thanks for your posts. I am really re-thinking things here. The thing is that we know the market is finite. So if the total market today is worth a set amount (whatever that is), and someone gains in the market then by definition someone else must lose.

And BBS, your example doesn't quite fit here. Is the gold actually increasing the value of the overall economy or is it just commanding a bigger share of the economy? I think its the later, where the gold doesn't actually mean that the economy is increased by that percentage, but that you get a slightly larger piece of the same pie.

That said though, I can see the point you guys make regarding the overall growth of the market and I can't completely account for that. So I guess I feel like the market is zero sum at any one point, but maybe that doesn't hold in the longer term, big picture. I don't know if that makes sense either, but I think that's where I am...

[Bring_Back_Shantz]

This is really interesting discussion and thanks for your posts. I am really re-thinking things here. The thing is that we know the market is finite. So if the total market today is worth a set amount (whatever that is), and someone gains in the market then by definition someone else must lose.

And BBS, your example doesn't quite fit here. Is the gold actually increasing the value of the overall economy or is it just commanding a bigger share of the economy? I think its the later, where the gold doesn't actually mean that the economy is increased by that percentage, but that you get a slightly larger piece of the same pie.

That said though, I can see the point you guys make regarding the overall growth of the market and I can't completely account for that. So I guess I feel like the market is zero sum at any one point, but maybe that doesn't hold in the longer term, big picture. I don't know if that makes sense either, but I think that's where I am...

In your first paragraph you say that the market is finite, but that's simply not true. The market as a whole can/does grow and shrink. Yes the market is finite, but that doesn't mean it can't grow over time, and as they say, a rising tide lifts all ships.

As to your second point, yes the gold does increase the value of the overall economy. If it didn't then we would never have seen any sort of growth in weath, or standard of living. We've clearly seen both of those things, so saying that creating/finding something of value simply commands a part of the already existing economy rather than adding to that overall value is just incorrect.

As for your final paragraph, it's not that the market is a zero sum game at any one point, that's not even true for a single stock. In fact it's the exact opposite of that.

If the market/a stock starts a a certain value, then at some point in time it will either be higher or lower than at that starting point. At that point in time on the whole it is either a net positive or negative gain. Yes there will be some winners and losers, but if the price is higher than it started, the sum total of winners and losers will be positive, if it's lower, then the sum total will be negative. The point of creating a company or market is to increase value. You do that by finding or creating something of value which adds to the overall value of the company. By it's very nature the market cannot be a zero sum game.

[Slava]

Yeah I guess that while I'm somewhat swayed and think you're right, I also think that there are some elements here that lean toward my points as well. The market is finite at any given moment. That point means that when someone gains, someone has to lose by definition. I just don't understand how you get around that.

I do think that the other six points I wrote about in my post still stand however. Even if I am wrong on this one (which I could very well be), I don't think that I'm completely out to lunch here.

[Bring_Back_Shantz]

Yeah I guess that while I'm somewhat swayed and think you're right, I also think that there are some elements here that lean toward my points as well. The market is finite at any given moment. That point means that when someone gains, someone has to lose by definition. I just don't understand how you get around that.

I do think that the other six points I wrote about in my post still stand however. Even if I am wrong on this one (which I could very well be), I don't think that I'm completely out to lunch here.

While it's true that it's finite at any given moment, where you are making a mistake is that you aren't considering that your position as winner or loser isn't based soley on the current state/size of the market, it also includes the state in the past where you entered the market.

If at that point all the market conditions are the same then you're right, for every winner there is an equivalent loser.

But we know that's not true, the size/value of the market fluctuates up and down.
If it's up, then the winners will outweigh the losers, and vice versa.

[Slava]

Yup, that is a very good point for sure.

[Buzzcock]

Good blog post. Gambling in the long run is always a losing proposition because of the vigorish. With every hand or roll of the dice the players have a negative expected return as the odds are slightly in the house's favour.

With the broader stock market, however, the odds are now in the investor's favour. The stock market has a long-run annual return of about 8% when adjusted for inflation. Brokers still take their transaction fees but the expected return for someone invested in the broader market is still positive.

I disagree with the argument that for an investor to make money someone else is losing money. As the famous saying goes....a rising tide lifts all boats. The market goes up and all long investors make money.

[Slava]

Who knew that all I needed to do to get some posts and reaction here was to say something that no one agrees with!

[GGG]

I forgot I posted here

I like to think of the economy like thermodynamics. The 1st law of thermodynamics is that energy can't be created or destroyed only transferred from one medium to another.

Extending this out money is a representation of energy. Human labour plus energy extracted from the ground. So essentially the economy can only expand if we add stored energy into the system via resource extraction or add human energy to the system more people entering the workforce or become more efficient and using either of these sources of energy.

So while on a universe level scale it's a zero sum game on an earth scale the stored energy in the earth in oil,iron, coal etc and the energy from the sun which feeds humans can be converted into economic growth.

However when we reach a point where the cost of energy increases or we stop growing as a population or stop getting more efficient economic growth will slow or stop.

I'm going to grab that book you mention as well. I do agree with you though that the risk management side of an investment adviser is valuable as while I don't believe stock picking is a skill setting acceptable risk tolerance for a probability of an acceptable rate of return is.

[V]

The stock market has a long-run annual return of about 8% when adjusted for inflation.

Is this accurate? The TSX is up an annual return of 6.1% since July 1979, and that's without taking inflation into account. So what's that, 3% if you consider inflation?

Kind of makes me want to just pay off my mortgage instead of taking the risk.

[Slava]

Is this accurate? The TSX is up an annual return of 6.1% since July 1979, and that's without taking inflation into account. So what's that, 3% if you consider inflation?

Kind of makes me want to just pay off my mortgage instead of taking the risk.

Well to do a proper comparison you would also have to factor in the gains of real estate over that timeframe against inflation. The numbers aren't as pretty as you might expect. When you look at the early 1980's in Calgary I think an average house was say $150k? Today that average is generously say $500k...probably less really. So the compound growth is 3.5% over 35 years if you use those figures. Maybe I'm off on the number of years here or the $150k to begin, but from a pure investment perspective that puts you slightly ahead of inflation over the long term.

[V]

Sorry, but what does paying off my mortgage have to do with house values? The return on paying off my mortgage is the mortgage rate, not the house appreciation, no?

[Slava]

Yeah I guess I was looking at that from the perspective of comparing the investment in a house with the investment in the markets. If the choice is pay the house or invest though then the hurdle rate would be the interest rate for the mortgage, and that makes sense.

[Buzzcock]

Is this accurate? The TSX is up an annual return of 6.1% since July 1979, and that's without taking inflation into account. So what's that, 3% if you consider inflation?

Kind of makes me want to just pay off my mortgage instead of taking the risk.

8% was the "rule of thumb" rate we used back when I took my finance degree and would have been the S&P500, not the TSX.

Using your July 1979 date, this link (https://dqydj.com/sp-500-return-calculator/)shows an annualized S&P return of 7.9% when indexed for inflation with dividends reinvested.

That's the S&P but your numbers still seem low for the TSX. I suspect 6.1% does not include dividend reinvestment. If you look up the TSE total return index that will show you the impact of reinvesting dividends.

[V]

Cool, thanks for that link. Using that calculator, it shows 5% without reinvesting dividends. That's a good point though that you should include reinvesting.

[Mr.Coffee]

Cool, thanks for that link. Using that calculator, it shows 5% without reinvesting dividends. That's a good point though that you should include reinvesting.

No, but hang on I think V has a point here even if you consider dividends reinvested. I think about this all the time and truly struggle with what to do with my excess money.

Paying down the mortgage is a lower ROI but assumes NO risk.

Investing in the market, even though demonstrated over the long run to generate approx. 5 or 8% ROI, still assumes risk. There's no guarantee that the stock market continually goes up and up and up.

Wars, major global depression events, global stagnation... I believe there are threats to the conventional wisdom that investments in the index automatically earn you that 5 or 8%. That decades lasting forever into the future will automatically generate returns. It is possible the index or market dips, even for a prolonged period of time.

Post World War 2 North American markets and economies are not the same thing as today's markets and economies, or the future's.

For the risk weary, paying down the mortgage likely is still a good call.

[Slava]

No, but hang on I think V has a point here even if you consider dividends reinvested. I think about this all the time and truly struggle with what to do with my excess money.

Paying down the mortgage is a lower ROI but assumes NO risk.

Investing in the market, even though demonstrated over the long run to generate approx. 5 or 8% ROI, still assumes risk. There's no guarantee that the stock market continually goes up and up and up.

Wars, major global depression events, global stagnation... I believe there are threats to the conventional wisdom that investments in the index automatically earn you that 5 or 8%. That decades lasting forever into the future will automatically generate returns. It is possible the index or market dips, even for a prolonged period of time.

Post World War 2 North American markets and economies are not the same thing as today's markets and economies, or the future's.

For the risk weary, paying down the mortgage likely is still a good call.

This is where it really depends on what your definition of risk is though. To me that means permanently losing the money. So paying the mortgage down saves you an obvious amount of money, that's true. But just like the index could dip for a prolonged period of time, so could a property. So in that case you've paid more into a property that has declined in value. I wouldn't consider that risk free, is all I'm saying.

[V]

Paying off your mortgage has nothing to do with property value, though. Even if your place devalues to zero, you're still paying 3% on your borrowed amount. So paying off your mortgage is risk free savings on that mortgage interest, independent of your property value.

[Leondros]

Paying off your mortgage has nothing to do with property value, though. Even if your place devalues to zero, you're still paying 3% on your borrowed amount. So paying off your mortgage is risk free savings on that mortgage interest, independent of your property value.

Actually it has everything to do with paying off your mortgage.

Think of it this way. You have a $300K mortgage on a $500K house.

Lets assume your rate is 3% and amortization is 25 years. That puts your payments at $1,422.63 per month. In the first year that means you are paying $8,888.09 in interest and $8,183.52 in principal.

For all intensive purposes you are paying close to $9K for borrow that money for the first year.

Now, lets say you run into $300K immediately after entering into said mortgage and have the option of either paying off your mortgage (we will assume without penalty) or investing that in the market.

We will assume the market will produce 8% in the same year. So for that extra $300K, you will assume roughly $24K. Alternatively you can chose to own your now $500K home.

By paying off your mortgage you are saving the $9K in interest per year, compared to making $24K in the market. What would you rather do? Well now we have house appreciation come into play, along with factors such as risk of not meeting the mortgage payments (say you lose your job and it impacts cashflow). If your house is projected to increase to $700K over the next 2 years, sure, your $500K house you own today 100% after paying off the mortgage will year $200K/3 years = $100K per year. That is pretty good.

However, lets say your house drops to $400K over the next two years (which is entirely possible here in Calgary). Well that's $50K lost each year in addition to the opportunity cost lost in being able to make $24K per year in the market.

Short story is, when making these decisions, appreciation or depreciation of the asset that you are planning to own (paying off the mortgage is increasing ownership) entirely should impact your decision. At the end of the day, you have to look at the value of that property. Just like every other financial decision there has to be a "terminal value" or exit strategy where the underlying asset or capital must be considered.

[V]

Ugh, not worth it.

I can't believe you wrote "for all intensive purposes".

[Leondros]

Fair enough - I just cannot wrap my head around how the underlying value of your asset (house) cannot at least be strong determining factor in a financial decision such as paying off a mortgage versus keeping it invested in anything else.

[Mr.Coffee]

Actually it has everything to do with paying off your mortgage.

Think of it this way. You have a $300K mortgage on a $500K house.

Lets assume your rate is 3% and amortization is 25 years. That puts your payments at $1,422.63 per month. In the first year that means you are paying $8,888.09 in interest and $8,183.52 in principal.

For all intensive purposes you are paying close to $9K for borrow that money for the first year.

Now, lets say you run into $300K immediately after entering into said mortgage and have the option of either paying off your mortgage (we will assume without penalty) or investing that in the market.

We will assume the market will produce 8% in the same year. So for that extra $300K, you will assume roughly $24K. Alternatively you can chose to own your now $500K home.

By paying off your mortgage you are saving the $9K in interest per year, compared to making $24K in the market. What would you rather do? Well now we have house appreciation come into play, along with factors such as risk of not meeting the mortgage payments (say you lose your job and it impacts cashflow). If your house is projected to increase to $700K over the next 2 years, sure, your $500K house you own today 100% after paying off the mortgage will year $200K/3 years = $100K per year. That is pretty good.

However, lets say your house drops to $400K over the next two years (which is entirely possible here in Calgary). Well that's $50K lost each year in addition to the opportunity cost lost in being able to make $24K per year in the market.

Short story is, when making these decisions, appreciation or depreciation of the asset that you are planning to own (paying off the mortgage is increasing ownership) entirely should impact your decision. At the end of the day, you have to look at the value of that property. Just like every other financial decision there has to be a "terminal value" or exit strategy where the underlying asset or capital must be considered.

agree and disagree with parts of this but again you presume that the 8% is guaranteed in your analysis in the market investment. It's not a fair comparison because 8% is not guaranteed. The return on the mortgage payout is risk free.

I don't think your analysis adequately considers risk.

[Leondros]

agree and disagree with parts of this but again you presume that the 8% is guaranteed in your analysis in the market investment. It's not a fair comparison because 8% is not guaranteed. The return on the mortgage payout is risk free.

I don't think your analysis adequately considers risk.

I completely agree - that was not the point I was trying to make however. All I was trying to say is that an analysis on whether to pay off your mortgage has to look at the value of your home.

Unfortunately from a risk standpoint and what we are seeing in Calgary is people's portfolios largely consist of oil and gas companies as this is what this city knows. This results in a far too heavily weighted oil and gas portfolio coupled with Calgary home prices being directly tied to the health of the same industry. This is where people are finding themselves in big trouble as their job, investments and house were all attached to the same underlying commodity (no diversification whatsoever).

[Slava]

I completely agree - that was not the point I was trying to make however. All I was trying to say is that an analysis on whether to pay off your mortgage has to look at the value of your home.

Unfortunately from a risk standpoint and what we are seeing in Calgary is people's portfolios largely consist of oil and gas companies as this is what this city knows. This results in a far too heavily weighted oil and gas portfolio coupled with Calgary home prices being directly tied to the health of the same industry. This is where people are finding themselves in big trouble as their job, investments and house were all attached to the same underlying commodity (no diversification whatsoever).

Well that lack of diversity is a hard one to argue against when times are good here. I've spent many meetings explaining to people that they ought to invest elsewhere because everything they have is tied to O&G. I joke that some people say they are diversified because they invest in oil and gas!

The problem is that when times are good there are more people than would care to admit that they want to "dance with the girl that brought them" along with a healthy dose of thinking they know a lot about the industry and are not going to fall victim to market declines.

All of that said though, that in and of itself is not a reason to not pay down the mortgage. While it is true that house prices could take a significant drop due to the oil issues we see today, it really hasn't materialised thus far. Obviously housing has declined to some extent, and in some price brackets the declines are steeper. But overall it doesn't look like there are exactly screaming deals for houses either. I'm not a real estate expert in any sense, but it looks like prices have dropped maybe 5-10% on average? That is more of a correction than a steep decline that is cause for concerns.

[heep223]

agree and disagree with parts of this but again you presume that the 8% is guaranteed in your analysis in the market investment. It's not a fair comparison because 8% is not guaranteed. The return on the mortgage payout is risk free.

I don't think your analysis adequately considers risk.

This is a very interesting topic and discussion.

I hear what you're saying re: the stock market not being guaranteed, but I think that's a far too simplistic approach. You're completely ignoring opportunity cost of your capital and most importantly, you are taking a short term view.

Global stock markets have returned 9.6% annualized over the past 115 years (1900-2016). This is through 18 business cycles (as detailed by the NBER Business Cycle Dating Committee), two world wars, the great depression, the great recession, the cold war, 17 US Presidents, terrorism, interest rates at 20%, interest rates at 2%....

Here's what $1M growing into $42B looks like by simply being invested in global equities. That is, the US, Canada, Europe, Japan, Australia and a composite of Emerging Markets (Russia, China, Brazil, India, South Africa, Eastern Europe, other Asia, etc etc):

http://i.imgur.com/gcVjE5al.png

Yes, it's not guaranteed as you say, and there are certainly drawdowns. But to me the biggest true risk with investing in global markets is a) your own behavioural and cognitive biases, and b) the way the system is designed that completely misaligns owners of capital (you) with managers of your capital (topic for another time).

More to the point, especially given that you can invest in this type of strategy for 0.25% or so these days, simply participating in global markets and adding when they drop will put you way ahead of paying off your 3% mortgage.

[Traditional_Ale]

Wouldn't the easy answer be to use the 24K a year to pay the mortgage down faster?

[Mr.Coffee]

This is a very interesting topic and discussion.

I hear what you're saying re: the stock market not being guaranteed, but I think that's a far too simplistic approach. You're completely ignoring opportunity cost of your capital and most importantly, you are taking a short term view.

Global stock markets have returned 9.6% annualized over the past 115 years (1900-2016). This is through 18 business cycles (as detailed by the NBER Business Cycle Dating Committee), two world wars, the great depression, the great recession, the cold war, 17 US Presidents, terrorism, interest rates at 20%, interest rates at 2%....

Here's what $1M growing into $42B looks like by simply being invested in global equities. That is, the US, Canada, Europe, Japan, Australia and a composite of Emerging Markets (Russia, China, Brazil, India, South Africa, Eastern Europe, other Asia, etc etc):

http://i.imgur.com/gcVjE5al.png

Yes, it's not guaranteed as you say, and there are certainly drawdowns. But to me the biggest true risk with investing in global markets is a) your own behavioural and cognitive biases, and b) the way the system is designed that completely misaligns owners of capital (you) with managers of your capital (topic for another time).

More to the point, especially given that you can invest in this type of strategy for 0.25% or so these days, simply participating in global markets and adding when they drop will put you way ahead of paying off your 3% mortgage.

You say I have a short-term view and then show me a 115 year chart. How long are you planning on living? The great depression lasted almost a decade of stagnated or negative growth.

Anyway I don't claim to know the answers, and certainly it is likely that buying an index and letting savings grow is likely the best plan, but I was just trying to point out that it doesn't mean it can't come with risk. And just because you show me a chart of 115 years, what did the past 400 years look like? Are you telling me that global economies are just forever up and to the right?

[Slava]

Well like a lot of these questions, the best answer is to do both. It's good to have the mortgage paid down, and also good to save the money. There are advantages and drawbacks to each. If you need money after you put it against the mortgage it can be really difficult to get at it; you can't pull down your eavestrough to pay for an unexpected expense. However adding more to the mortgage payment means that through time your monthly cash flows are better because that expense is eventually gone.

One of the challenges of planning in this area is discerning the goals and wishes of your clients. So while some people are both willing and able to put money in the market and wait out the potential volatility, others prefer to pay down the mortgage.

[heep223]

You say I have a short-term view and then show me a 115 year chart. How long are you planning on living? The great depression lasted almost a decade of stagnated or negative growth.



Anyway I don't claim to know the answers, and certainly it is likely that buying an index and letting savings grow is likely the best plan, but I was just trying to point out that it doesn't mean it can't come with risk. And just because you show me a chart of 115 years, what did the past 400 years look like? Are you telling me that global economies are just forever up and to the right?


If you look at any rolling 30 year period through this time, which is more realistic as to your point, annual returns vary between 8 and 14%.

I don't claim to know the answers either, only my opinion based on data. If I were a betting man I'd say that paying off your mortgage in the long term is going to significantly underperform a global, diversified portfolio of financial assets at current rates.

If you can't stomach volatility then that's a different story I suppose.

[Slava]

If you look at any rolling 30 year period through this time, which is more realistic as to your point, annual returns vary between 8 and 14%.

I don't claim to know the answers either, only my opinion based on data. If I were a betting man I'd say that paying off your mortgage in the long term is going to significantly underperform a global, diversified portfolio of financial assets at current rates.

If you can't stomach volatility then that's a different story I suppose.

Well you know that it comes down to both ability and willingness to take that risk though. So while it be perfectly sensible and might be the type of thing someone could handle financially if they're simply not willing to endure those ups and downs, or just "feel better" without that risk then that is the way you have to go.

[Mr.Coffee]

I think part of my problem is I'm pretty much just a crappy investor. I should probably just buy an index and let it ride, but because I like to feel dangerous I buy stocks and watch them... not do very well. I'm also probably too impatient of an investor, if I left good stocks that I buy alone, I'd do better. I'm averaging about 3.5% right now............. not the greatest.

So yeah I look at the old mortgage and just question all the time if I am doing the right thing.

[Slava]

I think part of my problem is I'm pretty much just a crappy investor. I should probably just buy an index and let it ride, but because I like to feel dangerous I buy stocks and watch them... not do very well. I'm also probably too impatient of an investor, if I left good stocks that I buy alone, I'd do better. I'm averaging about 3.5% right now............. not the greatest.

So yeah I look at the old mortgage and just question all the time if I am doing the right thing.

Well it just so happens that I know someone who can help you with that kind of thing!

[Enoch Root]

Slava:

Just discovered this thread and had a quick read, and I wanted to comment on your early point that the market is a zero sum game and that there is a loser for every winner.

As others have pointed out, that isn't exactly right.

The markets continually go up (over time) because the underlying companies create new wealth for their shareholders. If no one ever traded stocks again, the current shareholders would continue to experience new wealth creation.

What I believe you were getting at, with respect to winners and losers, is a reference to active trading (i.e. alpha). By making active investment decisions, investors deviate from the market return. Some actions will win, and some will lose, and they are a zero sum game. If someone buys a stock, someone sells that stock. So, if it goes up, relative to the market, then the buyer 'won', by experiencing a return greater than the market return, and the seller 'lost', by forgoing that return.

Overall though, the market return is what it is - the total growth of all the companies represented is a calculable number (but there is a return there, not a zero sum game).

It is individual investors, by choosing this particular stock, or shorting that particular stock, that are zero-summing their deviations from the market return. Some win, some lose.

As for dividends, they are no different than capital gains (other than tax consequences). A company takes the investments of its owners (shareholders) and generates a return on that investment. The company can choose to distribute that profit to shareholders (dividends), or retain that capital for further investment, creating capital growth and a higher stock price. Either way, it means a return on investment for the shareholders.

[Enoch Root]

re the pay down the mortgage vs investing decision:

The math works in favour of investing. As heep illustrated, the stock markets have returned about 9.5% per year for the entire period of available data.

Especially with current interest rates, that obviously favours investing.

However, the second part of the equation is the risk tolerance of the investor. Having debt makes some people very nervous. It is entirely valid for an investor to place more utility in the comfort of paying down their debt than in the (larger) growth of an investment.

Personal preference.

My advice is similar to what yours was: do both

[Buster]

Slava:

Just discovered this thread and had a quick read, and I wanted to comment on your early point that the market is a zero sum game and that there is a loser for every winner.

As others have pointed out, that isn't exactly right.

The markets continually go up (over time) because the underlying companies create new wealth for their shareholders. If no one ever traded stocks again, the current shareholders would continue to experience new wealth creation.

What I believe you were getting at, with respect to winners and losers, is a reference to active trading (i.e. alpha). By making active investment decisions, investors deviate from the market return. Some actions will win, and some will lose, and they are a zero sum game. If someone buys a stock, someone sells that stock. So, if it goes up, relative to the market, then the buyer 'won', by experiencing a return greater than the market return, and the seller 'lost', by forgoing that return.

Overall though, the market return is what it is - the total growth of all the companies represented is a calculable number (but there is a return there, not a zero sum game).

It is individual investors, by choosing this particular stock, or shorting that particular stock, that are zero-summing their deviations from the market return. Some win, some lose.

As for dividends, they are no different than capital gains (other than tax consequences). A company takes the investments of its owners (shareholders) and generates a return on that investment. The company can choose to distribute that profit to shareholders (dividends), or retain that capital for further investment, creating capital growth and a higher stock price. Either way, it means a return on investment for the shareholders.


The other significant factor is technology: efficiency drives wealth creation by deflating the real (not necessarily nominal) cost of most goods and services over time.

[Slava]

Slava:

Just discovered this thread and had a quick read, and I wanted to comment on your early point that the market is a zero sum game and that there is a loser for every winner.

As others have pointed out, that isn't exactly right.

The markets continually go up (over time) because the underlying companies create new wealth for their shareholders. If no one ever traded stocks again, the current shareholders would continue to experience new wealth creation.

What I believe you were getting at, with respect to winners and losers, is a reference to active trading (i.e. alpha). By making active investment decisions, investors deviate from the market return. Some actions will win, and some will lose, and they are a zero sum game. If someone buys a stock, someone sells that stock. So, if it goes up, relative to the market, then the buyer 'won', by experiencing a return greater than the market return, and the seller 'lost', by forgoing that return.

Overall though, the market return is what it is - the total growth of all the companies represented is a calculable number (but there is a return there, not a zero sum game).

It is individual investors, by choosing this particular stock, or shorting that particular stock, that are zero-summing their deviations from the market return. Some win, some lose.

As for dividends, they are no different than capital gains (other than tax consequences). A company takes the investments of its owners (shareholders) and generates a return on that investment. The company can choose to distribute that profit to shareholders (dividends), or retain that capital for further investment, creating capital growth and a higher stock price. Either way, it means a return on investment for the shareholders.

Yeah I like these threads and such in general because the discussion lets me re-think things and understand things more clearly in general. So while my thought on this has changed I decided to leave the original post as it was anyway.