This is a guest post by Rob Bennett
It’s a question you always hear after a stock crash. It’s usually asked in apologetic tones, as if it were a dumb question. It’s not. It’s a question that most of the big-name experts don’t fully grasp the answer to. Understand this one and you go to the head of class in Investing School.
When stock prices crash, where does the money go? It goes “Poof!”
That’s the truth. People think of stock investing as a serious business played by serious people. So they assume that there must be a complicated answer to this question. There must be some mysterious process by which the trillions of dollars of wealth that are lost in a stock crash disappear.
Nope. We can bid stock prices up to any level we want. We can all vote ourselves raises if we like. The only penalty is that, when we bid them up too high, they must crash back down in the following years. What is made from nothing must eventually return to nothing. It always happens that way. It always will happen that way. Now you know.
The strategy takeaway? Don’t invest too heavily in stocks when prices are high. Someone has to pay the bill for those times when we bid prices up too high. It doesn’t have to be you.
Rob Bennett is author of the A Rich Life blog and recently wrote a Google Knol entitled “Why Buy-and-Hold Investing Can Never Work.” (J: I don’t necessarily agree or disagree with “buy and hold,” (although I usually hold way more than sell) but I do find this topic interesting.)