An open question to Gary, or anybody else able to explain this to a financial dunderhead like me.

When you lose money in the stockmarket, where did the money go?

When you invest a $1,000 dollars in stock, see the worth climb to $5,000, then see the price drop so that the stock is only worth $2,500, what just happened here? Please explain.

-- j.r. guerra (jrguerra@boultinghousesimpson.com), September 21, 2001

Answers

In the stock market yes you do give up "physical money" to puchase "assigned value". This assigned value is a name for your investment (in your example $5,000.00). There is not 50 $100.00 bills (in physical form) stashed somewhere unless you chose to cash out. The assigned value changes often due to supply and demand, money does not change hands; instead the name of the assigned value changes. The $4,000.00 differance between investment and highest value never really existed unless you chose to take profit and cash out; the only time real money is involved is when you enter and exit. The money did not go anywhere, it never existed other than as a name.

-- mitch hearn (moopups@citlink.net), September 21, 2001.

I'll try to answer this simply here. Your $1000 bought part of a company when the marketplace valued that part at $1000. You still own that same part of the same company when the marketplace is willing to pay $5000 for that same part. Only the value has increased. You've not "made" anything when that happens. When the marketplace is willing to pay $2500 you've not lost a dime from the time the marketplace was willing to pay more for the same reason. At each of those points in time you still owned the same part of the same company. The only thing that changed was the value assigned to it by the marketplace.

You might want to think of it like an auction selling fungible items. You bought when the seller was willing to sell at $1000. Later in the sale, bidders were running the price up to $5000. Still later, the top bid was $2500. Each of you bought the exact same thing. You simply own it at different prices.

You don't "make" or "lose" anything until you sell. I hope this helps.

-- Gary in Indiana (gk6854@aol.com), September 21, 2001.

Thank you Gary and Mitch; I knew someone could explain it. Now a spinoff question?

How can the government tax an amount of money if that amount of money has not been realized yet?

Using the above example, how can the government justify taxing on the amount of $1500.00 profit ($1,000.00 initial investment plus $1500.00 of value of stock rising = $2,500.00), if I haven't removed the money from the stock market and realized my profit? I promise this is my last question, I swear to God . . .

-- j.r. guerra (jrguerra@boultinghousesimpson.com), September 21, 2001.

basically it never existed in the first place, in other words.

i would HIGHLY recommend you take a college course in money and banking. often these are offered at local community colleges, so you will not have any prequisite courses to complete etc. you can just walk in, pay the tuitition and take the class.

you will learn a lot about our money and banking system. absolutely fascinating !!!!!

-- gene ward (gward34847@aol.com), September 21, 2001.

j.r., Please don't make this your last question. I guarantee you there are others reading this who either wondered the same thing or at least were happy to learn how these things worked.

What you're talking about here is taxing "unrealized" gains in your portfolio. It's essentially an accounting activity no unlike allowing retailers to mark down their inventory values at year end due to aging (a new 2001 model car isn't worth as much December 31 after the 2002 models have been around for months). In that case, the value is lower, in this case (as you describe it) the values are higher. In each instance, the valuation is used to determine tax liability. There is a way to avoid that, however.

If you put your stock purchases into a tax-deferred retirement vehicle such as an Individual Retirement Account (IRA) those gains are not taxed annually, nor are dividends considered taxable income. All of that money grows and compounds on itself for years without being taxed along the way. The difference can be HUGE!

OK, I'll get down off my soapbox now. ;o) I hope this helps.

-- Gary in Indiana (gk6854@aol.com), September 21, 2001.

My DH was so freaked out over the market this week I had to keep him from the TV. "Don't you realize how much we've lost in the past week" he'd say. And I would tell him a loss isn't a loss until you sell it at a loss and since we are panic selling we haven't lost anything. In fact I consider this a big buying opportunity because the market will recover.

Rush Limbaugh said he researched the market and after every significant tragic event the market dropped, but recovered to pre- tragedy levels within 3 months, so that's your window of opportunity.

-- jennifer (schwabauer@aol.com), September 21, 2001.

Often your broker loans your shares out to someone wanting to sell them (short) and buy them back later to replace the ones they borrowed. So if they borrowed them when they were valued at $5k and replaced them when they were valued at $2.5k they made the difference. That is how a lot of traders make money in a falling market. Betting the stock will go down. If they sold short when the value was 5k and stock went up and they replaced when value was 6k they lost the difference. This might sound unfair but it adds liquidity to the market and actually helps. For you to buy someone has to sell.

-- ed (edfrhes@aol.com), September 21, 2001.

I've got a similar question, but mine has to do with why does/would a company worry about it's stock prices?

In my minds eye, the company sells stock to get money to expand/operate etc. Once they have sold the stock and have the investors money, what difference does the price of the stock mean to that company. No matter what happens to the price, they have their booty to use.

Over simplified I'm sure, but just wondering...

-- Willy Allen (willyalllen2@yahoo.com), September 22, 2001.

Willy, one reason companies want their stock price high is to avoid being taken over. If the stock prices drops below fair value for the company it becomes attractive to other large companies. They can buy the stock at a depressed price and then, once they own enough shares, take the company over. The old management then is generally out the door.

-- Joe (CactusJoe001@AOL.com), September 22, 2001.

j.r, 1st question, in most cases, if you lost money, someone else made money. Only in extreme downward movement and dying liquidity do most involved lose money. Even in this past week as the market tanked, some were making fortunes through shortselling and put options. Many index and stock put options gained 300-500% returns this past week. Quite a few everyday traders welcome the action we've had this past year because they're trading on the short side. 2nd question, unless you sold some shares or received dividends, you cannot be taxed on stock you hold. You don't even report stock holdings unless there's a transaction involved that year.

-- Dave (something@somewhere.com), September 22, 2001.

Joe, a companies valuation isn't based on share price but rather share price X outstanding shares = market capitalization. Thus a company with a stock share price of $10 may be worth alot more than a company with a share price of $100.

-- Dave (something@somewhere.com), September 22, 2001.

I won't try to convince anyone because so many believe it, largely due to listening to their brokers and partly because losing sucks and nobody likes to think about lost money. I have a few friends that are brokers, I'm in the process of getting my series 63 & 7 licenses now and I'll say that your broker is mostly in the business to sell you stock, stock they really don't want to own. If your account is with Merril Lynch or another big firm, most recommendations they give you will be stocks they were underwriters on or hold secondary offers on. The word comes down from above and next thing you know, your personal broker is calling you with an "opportunity". While your holdings sit there, they are trading with them, shorting against in times like this past year. Of course, they'll make money for you sometime because they want you to keep your money with them. If anything goes wrong they'll blame everything but themselves. If your brokers followed the advice they give you, they'd be out of business quick. A loss is a loss whether you've closed it out or not. You can hold and hope all you want but I can name off quite a few once prestigious companies that had high valuations that eventually went bankrupt. Holding a loss past 10% in most cases is not good money management. If you don't want to close the position and pay tax on gains, then protect your losses by 'boxing' the trade either with shortselling an equal amount of shares, buying puts or selling call options. Using those strategies will pretty much keep you from ever losing more than a small percentage, even in times like this past year. If your broker never explained those asset protection techniques to you, get a new one. I've made a little over 7000 trades during the past 5 years, at times 60 trades per day. I've caught on to alot of games that go on in the market during this time.

Regarding the panic comment, I disagree on that being what happened this past week. The selling was planned and orderly. All the market makers(dealers in the bidding and offering of shares on the open market) I talked to from merril lynch, goldman, lehman said they were going to be dumping big. They knew that before last weekend even though the talking heads were out telling the public to buy. Also, this selling in the market would have came regardless of the wtc event, it just came alot faster and in shorter time because of it. It's possible that we could bounce back up in 3 months time but I wouldn't count on it. I'm expecting we'll at least have a nice spike soon, very possibly this coming week (referred to as a dead-cat bounce in the market) Using the past as an indicator of the future is still just a guess. Many stocks are still overpriced based on historic price/earnings ratio valuations. With the economy as it is, earnings are still dropping and no turnaround is in sight. The dominoes are still falling.

-- Dave (something@somewhere.com), September 23, 2001.

Dave, I assumed Willy was not a complete fool. Who thinks you can buy ALL items in a store for the price of one item?

-- Joe (CactusJoe001@AOL.com), September 23, 2001.

ok. Sometime in the near future when the economy starts to pull out, we'll probably see alot of consolidation in all these tech industries. So many companies valuations are so low that it's cheaper for the big guys to buy them out than compete with them. One for example is PALM, makers of the Palmpilot and o/s. They were just spun off last year from 3com but their stock is so beaten down now that I'd think it'd look attractive to someone in the industry. It's one on my watchlist that's looking somewhat attractive right now. With the instability in the world right now it's pretty risky. Quite a few I'm waiting to buy call options on but not too compelled to jump in just yet. Will wait and see what happens tomorrow. Some people say buy the blood but I'd rather go long on something moving up rather than bottom fish.

-- Dave (something@somewhere.com), September 23, 2001.