Stock Market Crash is taking our money?

You have two questions: where does the money I invest go when my stocks lose value, and what are we going to do about it.

I'll take the first one first. For the benefit of people who might be new to investing, I'll take my time and explain it in detail, so forgive me if I'm going slow.

Say you bought one share for $100 and now it's valued at $95. It looks like someone took $5, right? The person you bought your share from (or the underwriter, if it was an IPO) took your $100 and gave you the share. If you were to sell the share now, you'd get $95 for it. Your $5 loss comes from the difference of what you paid ($100) and what you received ($95).

Now let's step back to a larger picture. Say 1,000 investors each bought one share of Helmuth Inc at $100 each. $100,000 total value has been put into these shares.

A bad earnings report comes out and 10 investors decide to sell. If I'm a buyer, I read the report, too, and I think Helmuth isn't worth $100 a share, so I offer to buy it for $95. For simplicity, say there are 10 other buyers out there who buy 1 share each for $95 each.

The market value of Helmuth stock is now $95 per share because that is the most recent price that a trade took place at. The market value of Helmuth as a company is now $95,000, which is the share price times the number of shares.

So, you and your investors put in $100,000. Me and my buyers put in $950 (10 shares, $95 each). The 10 who sold lost $5 each (total of $50), however Helmuth lost a market value of $5,000. So where did the other $4,950 go?

Answer: nowhere. It's gone. Market value does not reflect ACTUAL transactions. It's a "best guess" because you don't know how much something is worth until it is actually sold. No one gains or loses until their shares are sold.

By the same token, you might ask where the money comes from when there's a stock market rally - say that a good earnings report came out about Helmuth and 10 investors sold their shares for $120. Each gains $20 ($200 total). All the 1,000 shares of Helmuth put together are now worth $120,000. So $20,000 in value was gained, an additional $200 changed hands, so where did the other $19,800 in value come from?

Same answer: nowhere. It's pure market value. It doesn't mean real money until the shares are sold. No one loses or gains actual money on the deal.

There is one exception, and those are the short-sellers. These people essentially take a "bet" that the price of a stock is going to decline. What they do is borrow a share, sell it, and promise to give it back at a later date. They hope that the price declines over time so that they can buy back the share for more. Needless to say, if the price goes up instead, the short-seller loses money.

Now, I don't blame short-sellers for the stock market's descent. For one, not all stocks are short-sold. For another, short-selling was restricted for the past few weeks on many stocks, and yet the market tumbled.

Okay, your second question: what are we going to do about this.

That is the multi-billion dollar question in Washington right now. Honestly, I don't think they know what to do. I have a Master's degree and I don't know what to do. I'm sure the answer will be some form of nationalization.

Now, what can you, personally, do? If you're planning on retiring soon, you need to take a long hard look at your entire financial situation. Sit and talk with a financial advisor, if you have one (if you're a member of a credit union, financial advising is often available for free - to become a member, put $25 in a savings account there), and look at what you'll need, and what you have. If you can wait at all to sell shares that have dropped tremendously (such as my 85% loss on RBS stock), you may be better off for it.

If, on the other hand, you're not going to be pulling funds out for 20 years, just leave it in. Stocks gain value from the cash flows they provide (ie, dividends) and from the hope that someone else will want it in the future (ie, capital gains). You don't actually "lose" money until you sell your stocks at a loss.

Consider this: if the market value of Helmuth drops to $2, it looks like you lost 98% (since you bought it at $100). If you sell at $2, you get $2. If the company goes bankrupt, you get $0. However, if you hold on to your stock and the price goes back up to $90 when you sell it, then you lose $10. And if the stock goes up to $101, you made money if you sell it then.

I hope this helps. I know you're looking for who is gaining from the market crash, but the reality is that everyone loses in this sort of thing.