Is Market a Ponzi Scheme?

Charles Ponzi

I enjoy reading comments on other sites in response to how to prepare for retirement or how to invest or just on the capital markets in general.  It is obviously a good way to see immediate reactions from readers on various proposals and ideas.

There is, however, a certain group of commenters who are decidedly negative on whatever positive proposal is being made and on the economic system in general.  And I have to admit that I just don't understand them.  I get it that investing isn't for everyone.  I get that the volatility in markets leaves some a bit squeamish.  What I don't get is that so many (and it seems like a lot) are so negative on the whole investment process and that they, of all people, even read investment posts.

Here are two examples from a recent blog post :

Commenter #1: The stock market is a Ponzi Scheme. Anybody involved is a muppet or a muppeteer - the truest fools are the ones who do it to themselves and willingly. Get out before it is too late!

Commenter #2: Why do we invest in the market at all, other than that is what everyone else does? The more I think about it, the less it makes sense to buy stock in a public company. The point in owning stock is (1) you get a voice in management and can vote (2) you get a share of the profits through dividends and (3) you get a piece in liquidation or if the company is purchased. None of that stuff is real. All we are doing is buying something we think someone will pay more for in the future that really has no underlying intrinsic value. How is is different from buying tulip bulbs?

People will say: "Look at Apple, it has great profits, makes great products and has a lot of cash." Sure, but even with the annual $10 dividend per share, on a $600 share that is 1.4% and its the first dividend in 17 years. The only reason to buy Apple is other people are buying Apple. There is no connection to the underlying profits or assets of the company. I don't have an alternative, but I just don't get it other than it is illusory group-think.

The first commenter claims the stock market is a "Ponzi scheme."  A Ponzi scheme simply pays out more than it is earning.  I pay my "investors" $10 when I only make $2.  How do I do that?  By using funds obtained from new investors.  The scheme depends on constantly coming up with new suckers    à la Madoff.  It is hard for me to understand that anyone sees the stock market as doing that.  Just take   a look at dividend payout ratios, and it is easy to see that corporations pay out much less than they earn.

The second commenter brings up "tulip bulbs" and lists profits and dividends, mentions "no intrinsic value," and then goes on to talk about Apple Computer, of all companies.  I have to assume that he or she responded to the blog post on other than a Mac.  I would suggest that the commenter take some time and visit the Apple store at Columbia Mall, near where I live.  He or she will find that the store is crowded and difficult to even get into on just about every day of the week.  I don't know what gets more real than that.

Take a Broader View

But let's step back and take a broader view.  Think about where you came from.  In my situation, I know my grandfather came to America in the early part of the 20th century.  He came from Krasnopol, Poland.  I believe that, if you were to be back in the Krasnopol area 400 years ago, you'd find a windowless hut with a family who eats food we couldn't stomach today, facing unbelievably harsh weather conditions, and eking a living from the land.  Probably they were pig farmers.

Historians tell us that they probably didn't travel more than 50 miles from where they were born and, if they lived past 30 years old, they were considered old.

Today, in America and other nations with highly developed capital markets, life is much different.  In these countries, people travel all over the world, eat great food, drive automobiles, have unbelievable entertainment at their fingertips, and generally lead very easy lives.  My contention is that the difference between these two scenarios is the result importantly (not solely, but importantly) of the highly developed capital systems that have evolved over the centuries.

I would bet that the two commenters and most of their ilk are considerably closer to the second scenario than the first.

From risky endeavors, that supported sea-going operations enabling those willing to take the risk of losing their entire investment in return for the possible riches of precious metals from the new world, to today's raising of capital by companies involved in everything from cell phones to pharmaceutical drug research, the capital markets have come a long way.  And they have played an important role in financing the production of much of what we value in making our lives easier and more enjoyable.

Participants in this process who have followed some very basic principles have made out very well. Over the past 20 years, well-diversified portfolios that followed a basic asset allocation have more than quadrupled in value.

Are there bubbles?  Are there people who invest mindlessly just on the belief that someone else will pay more for their stock?  Of course.  This is all the more reason to follow widely-accepted principles of investing.  In fact, bubbles, where prices are driven to the sky, are dealt with appropriately by those who understand rebalancing.  But that is the subject of another blog post.