Someone recently asked me, 'Where does the money I have invested in a company, or the market, go when the stock prices fall? Can money just disappear?'
When you hear that the sharemarket has lost $40 billion dollars in one day, it can be quite terrifying. How can so much money be wiped off the market in one day? Unless your stock has been going up, it's difficult to make money in a falling market. In fact one of the few ways is to short sell stock or use options. Both these strategies are quite advanced and usually not the domain of everyday investors.
If you are an everyday investor, it can seem quite baffling. Who wears the losses when the market falls? Does the money just disappear?
The sharemarket is like any market. In fact, investing in shares is like investing in property. Prices go up and down in both markets and there is a primary market as well as a secondary market.
In the property market, the primary market is the initial transaction between the developer and the buyer. This is the only time that the developer gets money from the property. Even if property prices rise by 50%, the developer once they've sold the property doesn't benefit unless they develop and issue more units or buildings. Once the buyer sells the property to someone else, it's a private transaction that has nothing to do with the developer.
In the sharemarket, the primary market is the initial transaction between the company issuing shares and the first buyer. This initial raising of money is called an Initial Public Offering (IPO) or a float. Once this has happened, the shares then start trading on the secondary market which is the sharemarket. Once the shares are traded on the sharemarket, then just as the developer doesn't benefit after the initial transaction, in the same way, the company doesn't receive any money from buyers selling their shares to someone else.
If you hear that property prices have fallen by 10%, does the money just disappear? The money doesn't disappear but it does mean that sellers probably have lost money compared with the previous year.
If $40 billion dollars is wiped off the market in one day, it's just talking about the value of the Australian sharemarket shrinking.
Think of the Australian market as a business. The business is worth $990 billion at 10am but by 4pm the business is now worth $950 billion dollars. Then you could say that $40 billion dollars of the business has been wiped out in one day.
We measure the Australian market with a benchmark such as the S&P ASX 200.
The S&P ASX 200 is a basket of shares. It is made up of the 200 biggest companies listed on the ASX. BHP is the biggest company in the index followed by Rio Tinto. The bigger the company, the more the company has the power to move the index. That's because the index is weighted to size or market capitalisation.
When $40 billion dollars is wiped off the market, it doesn't just disappear. It means that the net effect on the market was a loss. So if you had bought the market at the beginning of the day and sold it at the end, you would have made a loss of $40 billion dollars.
It's essentially a way that fund managers measure the market so that they have something to compare their performance to.
So when you hear that the market has wiped $40 billion dollars, try not to panic. It doesn't necessarily mean that your portfolio is falling. It does mean that the benchmark that fund managers use to compare performance has fallen and the net effect of trading on the market has been a net loss.
What is probably going to be more use to you are the prices of the shares that you hold.
So take a deep breath and look at the shares that you own because these prices are probably the ones that are most relevant to you.
Happy investing!
Julia Lee Equities Analyst Bell Direct
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