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Buying Mutual Funds and the Greater Fool Theory

When you buy mutual funds, it is on what is called the secondary market. Many people say that if you are buying on the secondary market, you are subscribing to the greater fool theory This is basically what the secondary market means. Maybe you heard of the term “IPO” or Initial public offering. When a company grows big enough and they need more cash to grow, they can decide to “go public.” They decide, “It’s time for an IPO.” They sell stocks and shares of the company because they need cash to grow. So lets assume they sell 1 million shares for $1 each, for a total of one million dollars.

When they get that dollar from each of the million shares, they lose a cut because the person that set it up, the fund manager, gets a little cut. That is their commission. Let’s assume there are 10 people with 100,000 shares each out of that million. After that initial sale, additional sales, or trades, are on what is know as the secondary market. One person sells their shares to a buyer through a broker. Now, the mutual funds manager is going to get a little cut again, so the buy price is not the same as the sell price. This is called a spread. These trades go on over and over, thousands of times a day, endlessly.

All of those transactions after the IPO are on the secondary market. Does the company being traded get any of the commissions on sales of their shares? No. They don’t. That’s the shocker. The company only gets the money from the initial sale.

I think that’s the part that people really need to understand. It’s a share of a company, but really, what value is it? Like Mark Cuban said, “Back in the forties and fifties, when people bought shares, it was to support the company and help them grow.” Now people are buying it for speculation only. They’re buying stocks just to sell to the next person in hopes of making a profit off of them.

Some would call it the ”greater fool theory,” which states that it is always possible to make money by buying or selling a security, whether or not it is overvalued, because there will always be someone (a bigger fool) who is willing to pay the higher price. Unfortunately this system of mutual funds is where most Americans are put into for retirement savings. I don’t think that this is the best system for saving for retirement.

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