About $10 trillion (that's $10,000,000,000,000) has evaporated from the US stock market this year. The total market cap of all US stocks has dropped more than 20%, wiping out $10 trillion of value. To put that in perspective, $10 trillion is almost half a year's GDP – a measure of all economic activity in the entire country. Half a year's worth just disappeared from the stock market.
What happened to all that money? Whose accounts are growing exponentially while most Americans are drowning in despair watching their nest egg vanish before their very eyes? Because every economic transaction means someone gains and someone else loses, a debit and a credit, right? Wrong! The reality is that money never existed in the first place.
A stock price is the equilibrium between what a stock owner is willing to sell his share for and a stock buyer is willing to pay for that share. It's a real-time gauge of supply and demand. When more people want to buy stock instead of sell stock, the prices rise until a shareholder is willing to sell. The opposite happens when there are more sellers than buyers – prices fall.
Here's the thing: as prices increase because there are more buyers than sellers, financial markets present the higher price that a few buyers were willing to pay as if all shares could be sold at that price.
Let's say you pay $50 for a share of a company. The company has a total of 100 shares of stock, so its market cap is $5,000 (100 shares x $50 per share) at the time of your purchase. As time goes by, more and more people want to buy shares of the company, but you and your fellow shareholders are feeling pretty good about your investment, so you're reluctant to sell. The buyers aren't deterred. They offer $55, 60, 65, 70 per share. Eventually, a few shareholders are willing to part with their shares for $70, but only a few. And as the price increases, ironically, more buyers are interested in getting in on this incredible deal. They offer $75, 80, 85, 90, 95, 100 per share, until finally a few more shareholders are willing to budge for $100 per share.
Now, the stock price is $100 per share, and the market presents this price as if all shares are worth that price. But is that accurate?
Of course, you're feeling good about your investment. What cost you $50 is now worth $100! But is it really? Do you have $100 in your bank account? No. What you have is a share of stock that is hypothetically worth $100 if you sold it today.
The market cap of the company has doubled to $10,000 (100 shares x $100 per share). But does $10,000 actually exist in the economy? Is that money sitting in an account somewhere? No.
That $10,000 is the total value of all 100 shares of the company, if sold today. But is it really? What if all 100 shareholders decided to sell today? Well, all of a sudden, there would be far more sellers than buyers ... so what would happen to the price? It would fall, and rapidly! Could all 100 shareholders get $100 for their shares? Most definitely not.
As fortunes reverse, shareholders try to bail, but they quickly realize buyers aren't too thrilled about the investment now either, so maybe buyers are only willing to pay $75 per share. Uh oh, the market cap of the company dropped to $7,500 (100 shares x $75 per share). And just like that, $2,500 "disappeared" from the market.
Extrapolate this example to all publicly traded companies and you can see how $10 trillion disappears. It was never really there to begin with. It was a measure of what people were willing to pay for stocks at the beginning of the year because buyers were plentiful and sellers were few. But as soon as people became fearful and wanted to sell, prices began to drop.
Interestingly, after the stock drops from $100 to $75 and you've "lost" $25, you're much more likely to panic and sell. Yet you haven't actually lost anything yet, other than the opportunity to sell for $100. But that ship has sailed. You can't sell for $100 any more.
So, instead of focusing on what you "lost" and fearing what you still may lose, ask yourself if your investment is worth $75. If it is, hold on to it. If it isn't, time to sell, and time to reflect and ask yourself why you didn't sell for $100 when you had the chance.
The important thing is that you don't panic sell! As people panic sell, prices continue to fall and more people panic sell. It's a vicious cycle and one that inevitably leads to prices falling below their fair value, which means a great number of those panic sellers will sell at the wrong time, when the price doesn't reflect the true value of the investment. On the flip side, that means opportunity for shrewd, patient, level-headed investors who are able to keep their cool and buy when everyone else is running for the exits.
You didn't lose $25, nor did $25 disappear from the economy or line someone's pockets. Actually, you wisely paid $50 for what others are still willing to pay $75 for. Well done. As prices fall, see if you can find another bargain.