Are Capital Markets Ergodic?


Nassim Taleb talks often of ergodicity which is tough to find a simple definition for, but Taleb tweeted this excerpt from The Black Swan to explain it.

Before I knew the word, I would write that over long periods of time, the equity market will go up something like 7% or 8% annualized. This includes all the great years and all the terrible years, 7-8% in all likelihood. Any deviation from there would be modest as opposed to all of a sudden jumping up to 20% annualized. This does not mean returns will be linear, the same 7-8% every year. Last year was a huge up year for the S&P 500. Occasionally there are huge down years. Think about the last 20 years, the math checks out.

If you do nothing in your portfolio but hang on no matter what and have a reasonably diverse allocation then you will be somewhat close to that long term average. That is where ergodicity comes into play. The more frequently you trade, the more you push against the ergodic benefit of markets. It's not that changes never need to be made, not the point at all, but a diversified portfolio looking to benefit from long term trends shouldn't need to trade on a weekly basis. Too much trading and the market is no longer working for you. Yes, there are plenty of great traders out there, but they are not the majority of market participants.

Too much trading also poses the risk that you end up being correct for the short term but wrong for the long term. No one who is planning and investing for retirement will remember having beaten the market when they were 49 if they don't have enough money for the retirement they want when they are 65 or 70 or whatever age they care about.