The caller wanted to know what happened to all that money ($11 trillion or more depending on when you start your calculations).
The caller wanted to know what happened to those trillions of dollars and who got them.
I tried to explain, but the caller remained unconvinced. Later, as I reflected on the interview (and with some prodding from my wife) I realized that I had committed a common error of people in the investment business.
I assumed something that was obvious to me was also obvious to people who didn't spend most of their day thinking and reading about investing.
Not a pleasant realization for someone who earns money educating investors.
The financial services industry has not done a good job educating investors about what can and does happen to the money they invest in stocks and bonds.
Clearing Up the Mess
So, here's a shot in clearing up some basics that have been skipped by the financial services industry (and I will plead guilty also).It seems to me the problem of perception comes down to understanding the difference between investing and saving.
While both involve entrusting your money to an organization, the potential outcomes are quite different.
What is more, those outcomes are driven by completely different influences.
Let's start with saving. If you deposit $1,000 in a savings instrument such as a savings account, money market account or CD, you expect that money and accumulated interest will be available to you when you need it.
Indeed, if you put money into an account insured by the Federal Deposit Insurance Corp. - basically any bank - you can count on the money being there when you need it. The same is true of savings and loans and credit unions, although there may be a different insurance involved.
No depositor has lost money in any federally-insured saving account within the insurance limits (usually $250,000 per account).
Even If Bank Fails
Even if the bank fails, the worse that can happen is you may lose any earned interest, but you will get your money back.This safety is one of the reasons bank interest rates are usually low. U.S. Treasury issues such as bonds, notes and bills, which are safer than bank deposits, pay an even lower interest rates.
Bottom-line: if you deposit $1,000 in a bank account, you will always have $1,000 plus interest. (For this illustration, we'll ignore the negative effects of inflation and taxes.)
Investing
Now, what happens if you give $1,000 to a stockbroker (or mutual fund) to invest in a stock?The broker will buy as many shares as the $1,000 will cover in your name. For example, you can buy 50 shares of a stock costing $20 per share for $1,000 (ignoring commissions and taxes for this illustration).
As long as the price of $20 per share doesn't change, you still have access to $1,000 if you want to sell. You are also a part (probably a very small part) owner of the company. This is an important distinction from the saver who is not an owner of the bank.
However, other investors that own the stock become concerned about the company's future. They want to sell their shares and move on to another investment.
If enough other stockholders sell their shares, the price of the stock may begin to drop. It drops because finding buyers becomes more difficult and when you have more sellers than buyers, the sellers must lower their price to attract buyers.
You haven't offered you stock for sale at any price, but now if you decide to sell your 50 shares, you will have to accept what the market is willing to pay and that may be less than you originally paid.
If the current market price is $15 per share, that's what you will receive if you decide to sell (again, ignoring commissions and such).
Show Me the Money
What happened to that $5 per share or $250 dollars you won't be receiving? (50 shares at $15 per share equals $750 or a loss to you of $250)No one got that $5 per share or $250. It simply vanished because the price you had to offer a buyer to complete the sale was $5 per share less than you paid.
You take a loss in your investment and that's the big difference between saving and investing - the potential for loss.
Of course, it works the other way also. Other investors might h decide the stock was a good buy. To induce owners to sell, buyers will raise the price they are willing to pay.
More buyers than sellers means the price per share will rise as buyers try to coax owners to sell.
If the price goes to $25 per share, your $1,000 original investment is now worth $1,250. That's the other difference between saving and investing. You will never make more than the stated interest rate on a savings instrument, while an investment has the potential for unlimited growth.
Bottom Line
Here's the bottom line. If you know you will need your money within five years, you should consider putting it in savings instruments. If you can wait more than five years and are willing to risk suffering a loss, investing potentially pays much more than saving.Savings assures you that you will get your money back, while investing offers the potential, but not the guarantee, that you will earn a higher rate of return.
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Back to: Introduction to Investing in Stocks
