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Where Does the Money Go When the Market Is Down?

A reader writes in, asking:

“One thing I’ve never understood is where the money goes when the stock market goes down. Let’s say the market is down a collective $100 billion over a period of time. Did the money just disappear? Did it go to cash or some other asset? I have the same question when the market is up. Where’s the money coming from?”

The money doesn’t go anywhere, per se. If the stock market’s value is down $X, it isn’t because $X actually moved out of the stock market and into other asset classes. What’s actually going on is easiest to explain by analogy.

Imagine that you buy a home for $300,000. One year later, you hire a qualified appraiser to assess the value of your home. His answer is that based on recent sales of similar homes in the area, your home is now worth $270,000. Your home declined in value by $30,000, but that $30,000 didn’t go anywhere. And no cash has even changed hands at all.

And the same thing can of course happen in the other direction. (That is, your home could increase in value without any cash changing hands.)

A similar thing happens with stocks. The difference is simply that the most recent price at which the stock has traded is generally considered to be the current value.

For example, imagine a company that has 1 million shares of stock outstanding. If the stock is currently worth $90, the company’s total market capitalization (i.e., total value) is currently $90 million.

Now imagine that you have 1,000 shares of stock in this company, and you want to sell it. But at this particular point in time, the highest price anybody happens to be willing to pay for the stock is $89.

You sell the stock, meaning that $89 is now considered to be the market value for each of the company’s 1 million shares. So the total market capitalization of the company is now $89 million, or $1 million less than a few seconds ago. But only $89,000 has changed hands. And, in total, no money at all actually came into the market or left the market. (The buyer put $89,000 into the market, but you took $89,000 out of the market.)

In other words, the market can go up (or down) by quite a bit with only a relatively small amount of money changing hands. This is a result of the fact that when shares of a company are traded at a new price, all shares of that company (or more specifically, all shares of the same share class of that company) are now valued at that new price.

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