Who’s the culprit? Amid the financial chaos of 2009, I vividly remember a friend asking, “who stole the money?” She had seen a news story about how much market value had been erased and presumed that since the money was gone, somebody took it. That’s not how the markets work and during times like these, understanding the markets is especially important. After the largest inflow of money into mutual funds and exchange traded funds in history, we have seen $4 trillion of value disappear in a single month.
With the notable exception of the Dow Jones Industrial Average, most indices that you watch are market capitalization-weighted. The Dow is price-weighted, so the higher the price of a stock, the less of a percentage move is required to register a significant impact on the index.
Market capital-weighted refers to the price of the stock multiplied by the number of outstanding shares. While every “pie” has just 100% to divide, there are no rules restricting how many pieces of the pie you can have. Microsoft has almost 7.5 billion shares outstanding according to Yahoo! Finance, while Harley Davidson has roughly 165 million shares outstanding. The difference between their respective $90 and $47 share prices pales in comparison to the range of market capitalization.
A second issue to consider is the volume of stock. Microsoft has 7.5 billion shares outstanding, but only 25 million shares trade on an average day. Monday’s volume was 50 million shares. The decline in value based on traded shares was imposed on all the other shares that were not bought or sold. More people sold than bought stocks on Monday, and the closing price was then applied to all 7.5 billion shares. That explains a roughly $4 trillion loss in market capitalization. So, in response to my friend’s query in 2009, nobody got the money.
We teach our families that individuals generally pass through three stages of finance. During the accumulation stage, we save for the future. In the preservation/consolidation stage, we may still be saving, but preserving the funds amassed matters far more than the amount contributed in a single year. Finally, we reach the distribution stage when money is withdrawn to enhance our retirement income and support our desired standard of living.
If you are in the accumulating stage, the last few days have been incredible. You are purchasing stocks during a time of downside volatility. Frankly, investing scenarios don’t get much better. If you are in the preservation stage and have the discipline and fortitude to maintain your strategy regardless of volatility, then this day, month, week and year does not even matter in the long term. If you are in the distribution stage and withdrawing money from your retirement portfolio, you hopefully had a level of cash available to weather the periods of short-term volatility that are part of every investment cycle. In short, it’s all good if you have a plan and the discipline to follow the plan.
Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer.
