We all know that it is dang near impossible to beat the market over any extended period of time. We all know that we are better off in index funds.
But do we invest in index funds? No.
We open up accounts at Robinhood and Coinbase, trade a bunch of futures and options, subscribe to newsletters and trading services, read books on how to beat the market, and waste a lot of time and energy trying to beat the market when we know it is impossible to beat the market.
Why do we do this?
Because it is fun.
I’m actually being serious. We do this for no other reason than our own amusement. Finance is a hobby for many people. We may be teachers or doctors or lawyers in our day jobs, but we punt around stocks in our free time. Easy to do now that all the trading apps are available on a mobile phone. And of course, people do manage to beat the market for short periods of time, but there are only a handful of people in the entire world that can do it consistently. The case of the exceptional manager.
Finance has not one, not two, but three TV channels, some with more drama than others. And there is drama, and there are personalities. It is one giant soap opera. One thing I’ve noticed about ESPN is that there is not a lot of sports on ESPN. It is mostly talk shows, with the hosts trying to create drama and controversy when there is none. The same is true of finance. We need stories, struggles between good and evil, and the best content CNBC has ever had on that channel is when Michael Lewis got into a shouting match with some HFT guys around the release of Flash Boys. Now, that was drama, and everybody loved it. Of course, Michael Lewis was dead balls wrong about the HFT guys, but everyone has forgotten all about it by now. It was fun.
Options trading is a zero sum game. I win, you lose, you win, I lose. I’m not saying it doesn’t serve a purpose—risk is transferred from those unwilling to take it to those willing to take it, which is an important function of markets. But most options trading is recreational. It certainly was in 2021, with the degenerate call buying on the meme stocks. Sure, there are covered calls and cash-secured puts and slow boring strategies like that, but a lot of options trading is people trying to make 10x or 50x returns. Not too different from having a spin at the Roulette wheel. There has been a lot written in a lot of places about the differences and similarities of investing with gambling. I think the biggest difference is that gambling is supposed to be fun, while investing is supposed to be serious and boring. Well, we all know that finance is not serious and boring. Dumb, crazy shit happens all the time. And people will take the stuff that is slow and boring and turn it into dumb and crazy, like auction rate securities. Decades ago, people used to actively trade mutual funds, years before Robinhood came around.
Speaking of Robinhood (I am not a customer), a lot has been written about the gamification of finance, about how Robinhood took something that was slow and boring and turned it into a video game with whiz-bang visuals and sound effects, neural hacking that was designed to get people to trade more and more often. Nobody opened a Robinhood account because they thought that investing was slow and boring. They did it because they thought it would be fun! And Robinhood made it fun. The millions of people who were day trading on their Robinhood apps were doing it for pure entertainment. Sure, people thought they could get rich doing it—but they were having fun in the process. Except none of them got rich. They got poor, which was not so fun.
Having worked on the institutional side of the business, I can tell you that it was not all slow and boring. Even hedge funds traded for amusement. Things would get slow, and people would start ripping around SPYs and QQQs. I can tell you that I personally executed trades that had no economic purpose whatsoever. It was the middle of the day, I had just eaten a charcoal chicken panini, food coma was setting in, and I was bored. Human behavior, man.
Maybe bonds are slow and boring? You must not know any bond traders. There is more than enough degenerate gambling in the bond market to go around. I suppose the most boring aspect of the bond market is when big asset managers hoover up tens of millions of bonds at issuance, and then hold to maturity. There is definitely an economic purpose to that. But I can tell you that the business of making markets in bonds is not slow and boring. There is a lot of gamesmanship, and a lot of fun.
When I first started investing, at age 23 in 1997, I decided to compartmentalize my financial life. I was going to have a slow boring part (index funds) and a fun part (actively managed stuff). And I suspect that is what most people do. They have serious money and fun money, and they take big risks with fun money, because it is fucking fun. That is why they do it. The danger lies when you have your entire portfolio as fun money, which is what a lot of people did in 2021. People have a psychological need to punt stuff around. I get it. I am the author of a personal finance book that is coming out next year, and I talk about this psychological tendency. Even Taleb wrote about this in Fooled By Randomness. He said the ideal portfolio was 90% slow boring and 10% exposed to moonshots, stuff that gains from disorder. Right tail stuff, like venture capital. I 100% agree with this philosophy, and it is basically how I structure my own affairs.
If finance wasn’t fun, then people wouldn’t trade so much. Over the years, we have had these discussions about implementing a financial transactions tax which would discourage people from trading all the time. I don’t think this is such a good idea. Anything that reduces liquidity is bad. But Charlie Munger disagrees—he wishes we didn’t have so much liquidity so people would buy and hold things for 40 years. Maybe he is right, but nonetheless, the world we live in right now with practically frictionless trading is pretty great, because transactions costs will eat into people’s returns. There are problems with our current market microstructure, the biggest being that trading costs are implicit rather than explicit, but I do not have faith in a wise and benevolent regulator who can identify these problems and correct them without nasty unintended side effects.
As the purveyor of a newsletter, I can tell you when enthusiasm for finance waxes and wanes over the years. 2021 was my best year in history, in terms of new subscription revenue. 2020 and 2022 were pretty good. 2023 is terrible. Everyone was burned by the bear market, things are boring, they don’t see opportunities, and nobody wants to read about markets. This isn’t specific to just me—the entire newsletter “industry” has been affected. You might say that it is greed that waxes and wanes, but really, I think it is the need for financial entertainment. I am part of the financial infotainment complex. And one of the reasons that I’ve been as successful as I have is because I provide entertainment in addition to financial deep thoughts. I am not bashful about that. The goal of The Daily Dirtnap is to make money, but a secondary goal is to have fun. Sometimes markets are boring, and the funny, lighthearted stuff carries you through.
This is all part of a broader thesis about how everything is entertainment. Between streaming services, social media, and other apps, we have more entertainment competing for our time than ever before. Finance is just a part of it. But I think it’s important to be honest with ourselves. This is not a serious business, and these are not serious people. And the people who think it’s serious and take themselves so seriously are unserious. More about that next week.
Besides entertainment, there is a very significant value to be derived from playing market games. It develops a numeracy and financial sophistication that is relatively rare, and entirely applicable to personal finance situations. Should I rent or buy a home? Should I refi my mortgage, and if so should I do a cash-out refi? There is also value to this knowledge when investing in less sophisticated and less efficient markets, such as local (small town) real estate, or if one has a managerial or executive role in a company. Intuitively understanding concepts like NPV, volatility, liquidity, the difference between cash value and earnings ("earnings are theory; cash flow is reality"), and option premium help drive good decision making...as long as you can keep common sense and not get blinded by your own formulas and spreadsheets.
Engagement is money in a world of entertainment