If you own an income investment and the stock market goes down, do you lose all your money?
Yes, that's a newbie question, but many people are newbies to investing, who don't understand what experienced investors take for granted.
The Way Everybody Including Experts Talks Does Confuse Stocks With Money
And I can understand why they're confused. In my opinion, almost everybody else who speaks and writes about the markets -- including all the experts -- exhibit confused thinking and poor communication skills on this issue.
You see, there's a fundamental detail here that almost everybody misses -- stocks cost money, but stocks are NOT money.
The Liquidity of the Stock Market Fools Us
Let me repeat that, because it's important.
Stocks cost money. Yes, they do have an ever-changing market price.
But stocks are NOT money. Yes, you can sell them for money any time the exchanges are open for business, but they are NOT money.
If you printed out some of your Google shares, you could not take them into a store and buy something with them. They're worth some money, but they're not money itself.
You Give Up Money When You Buy the Stocks
When you invest in stocks, you transfer some of your money into an account at a brokerage. The brokerage holds your cash in a money market fund, sort of like a bank holding your cash in a checking account, waiting for you to tell them to do something with it.
However, all a brokerage will do with it is buy securities or give it back to you.
When you give them an order to buy 100 shares of Coca-Cola, they take the necessary cash out of your account (which includes their commission, of course!). That amount of money is now gone. In its place is 100 shares of Coca-Cola stock.
Your money is now gone. You exchanged it for the 100 shares of Coca-Cola, which cost money, but are not money.
Just like when you buy a car. You exchange money for the car. The car is worth some money -- you could resell it tomorrow. But the car is not money (it's a car).
Unclear Communication Reflects and Encourages Sloppy Thinking
I may seem to be belaboring the obvious, but even the experts are careless in how they talk about this, and it makes for inaccurate thinking.
If the price of Coca-Cola goes down by $1 per share tomorrow, have you lost any money?
No. You still own the 100 shares. If you sold them, you would receive $100 less than what you paid for them yesterday, but you haven't lost any money, because shares of stock are not money.
They do have a price for buying and a price for selling, which always fluctuates, but they are not money.
If you closed your eyes tonight and went to sleep for twenty years like Rip Van Winkle, would that make any difference to those 100 shares of stock?
No. They'll go up and down in market value every business day for the next twenty years, but if you ignore that (because you're sleeping), they just sit there in your brokerage account.
Most Investors Would Be Better Off If They Did Forget Their Investments For the Next 20 Years
When you wake up in twenty years, those 100 shares will be worth whatever the stock market price is then. Hopefully it will be higher. Have you made any money?
No, because you still have 100 shares, and -- one more time -- stock shares are not money.
If their market price is higher, then you can sell them, and then you have made money. But you no longer own the 100 shares. You exchanged them for money.
Only When You Sell Stock Shares Do You Realize a Gain or Loss
Therefore, the only way to lose money in the stock market is to sell shares at a price lower than what you paid for them. If the market price is too low, don't sell. (Sometimes you should sell, because the company is about to go out of business and you just want to get whatever you can before your stock is worth $0. Enron was a good example.)
However, income investments can make you money by holding them.
Stocks That Pay Dividends Pay You to Own Them
If you hold on to Coca-Cola shares of stock for the next 20 years, you'll be paid dividends every quarter. Therefore, in 20 years you would wake up to find you owned the original 100 shares, plus you cash balance is higher by the amount of the accumulated dividends paid every three months.
Also, you can arrange with your stock broker to have the dividends automatically reinvested in shares of Coca-Cola. In that case, you'll wake up with the original 100 shares plus all the shares your dividends bought every quarter.
That's the simple genius of income investing. Invest. Receive income from investing. Reinvest said income. Receive even more income from investing. Continue until you retire and live off the income.
So when the market price of an income investment goes down, you have lost nothing unless you're foolish enough to sell at that time.
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