Re: Investments

Robin Hanson (
Mon, 26 May 1997 11:00:51 -0700 (PDT)

I wrote:
>Avoid making bets with other people, and everything but buying an
>average such as an index *is* a bet. One of you will lose the bet ...

Peter C. McCluskey responded:
>There is no way to avoid making a bet when investing. All you can do
>is choose between low risk and high risk bets. Buying an index today
>is a bet that todays index prices aren't inflated by abnormal
>popularity of index investing. ... It is important to avoid making
>bets where the person you are betting against has more info than you.

Here's what I meant. Imagine that everyone in the world had the same
investment portfolio, with the same relative fraction of their wealth
in each investment made anywhere. Rich people would have more shares
of this portfolio, but otherwise everyone is the same. In this
situation, I would say no one is making a bet, though everyone does
suffer risk regarding the performance of the world economy as a whole.

For anyone whose portfolio differs from this average portfolio, one or
more other people must hold the negative of this difference in their
portfolio. I say two sides are making a bet; whatever one side gains
the other side loses. Each side also now risks that the other side
has better information.

Some bets are good for insurance reasons; different people may have
different risk tolerances or different state-dependent preferences for
wealth. Some bets are also good because they are on what people will
choose to do, and we can prefer to give people incentives to do the
right thing. But beyond this, one side in a bet is making a mistake.

Since actual index funds are not exactly the average world investment,
they are bets regarding the difference. But as you put together
enough indexes and approach the average, your total portfolio
approaches not making a bet.

Robin D. Hanson