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"Ask Marilyn" Flubs One

By The Reverend Published: July 21, 2009

Marilyn Vos Savant is an extremely brilliant woman who writes answers to questions in the Sunday Parade magazine. This past Sunday, I think she flubbed one, badly. Take a look...

My wife and I have lost more than a third of our life savings in the stock we set aside for our retirement. How can our hard-earned dollars given to a company for a share of stock just disappear? Where is the money now?
—Herm Voss, Shasta Lake, Calif.

Surprise—the money doesn’t go to the company at all.

Except for initial public offerings and certain later stock issuances (neither of which are on the open market at first and account for only a small fraction of purchases anyway), the company gets nothing. You buy stock from other investors. They get your money.

So far, so good. Marilyn clears up the "investing in a company when you buy stock" part. It's simply fiction.

When a growing number of people buy stocks—and from one another, remember—prices are driven up because buyers outnumber sellers. And as brokerage statements indicate the last selling price of the stock, investor portfolios become inflated.

Yes, more buyers than sellers of a stock results in auctioning the price of the stock higher. Good up to this point....but then, Marilyn misses it...

The economy can get into big trouble this way. You can’t buy the same stock back and forth numerous times, inflating its price, and think that you’re creating real dollars. Yet that’s just how many investors behave.

When you receive your stock statement with it's "inflated" portfolio value, Marilyn says the stock isn't really worth that stated amount. She asserts that "real dollars" have not been created. I beg to differ.

If I buy 100 shares of Goodyear stock the 15th of the month....get my monthly statement on the 20th saying that Goodyear stock is worth $1 more per share than I bought it for.....and then sell the stock on the 21st for 75 cents a share more than I paid on the 15th.....THAT'S REAL MONEY, not created money.

Marilyn goes on to compound her mistake...

To illustrate, say that 10 million investors each own 100 shares of stock in a company. Then I pay $1 more than the last fellow for a share. As a result, the stock price goes up by $1, and all 10 million shareholders see their portfolios rise by $100. But did I create $1 billion of wealth, the total of that increase? Of course not.

At the close of the day Marilyn is referring to, hypothetically, you're darn tootin' $1 billion of wealth has been created. The additional wealth empirically appeared in the form of higher prices buyers were willing to pay for the stock. Banks, brokerages, and insurance companies consider that "inflated" stock value as real money, real wealth. They will loan more based on higher stock value collateralization. It's real wealth.

But then Marilyn kind of embarasses herself....

This apparent $1 billion was generated by what I call the “Cheshire multiple” (after the disappearing cat in Lewis Carroll’s Alice’s Adventures in Wonderland). It exists mostly in the imagination.

Only a small percentage of investors can sell their shares at the price on their brokerage statements. As soon as sellers outnumber buyers, the price will fall and portfolios will shrink due to that same multiple. It works both ways. So most of this so-called money simply vanishes. No one gets it.

If "a small percentage of investors can sell their shares" at the price on their statement....."so-called money" isn't simply "vanishing".....some stock sellers are putting it into their pockets. The profit placed into the accounts of sellers doesn't "exist mostly in the imagination", it's really there.

What Marilyn doesn't get is that the stock market is a zero sum game. For every winner there is an equal but opposite loser. Read any material from any knowledgable source on the market and you'll find that this is common knowledge.

When a third of your portfolio value has disappeared, sellers who purchased the same stocks you did, only at a much lower price than you originally paid....are selling and "taking" that difference in price and putting it into their accounts.

One last elementary example. At 10 AM, I purchase 100 shares of GE stock at $10 a share. At 3 PM, I sell my 100 GE shares for $10.50 a share. I produce $50 of wealth for myself. Where did that $50 come from? Was in just "so-called" wealth, was it just imaginary?

From the second I bought 100 GE shares at 10 AM, other buyers bought GE stock and they were willing to pay a bit more than me. That pattern continues all morning and into the afternoon. By 3 PM the new buyers who bought AFTER me, have driven the price to $10.50. I sell my shares and make a profit. That profit, that wealth, comes from the difference in price new buyers were willing to pay after I made my purchase. The new, higher price new buyers were willing to pay was paid with real money.

There's nothing imaginary about it.

This goes on every business day. Wealth changes hands zeroing itself out every day. For every winner there is a loser. Translate that dynamic into a monthly statement which reflects 20 such business days activity and you simply have a collective number which reflects the transfer of wealth from accounts to accounts. Real wealth that the winners don't, in the least, regard as "imaginary".

When your 401K or IRA used to be worth $10,000 and now is only worth $5000.....that lost $5000 that used to be part of your personal wealth wound up in the accounts of others who now own the $5000 of wealth that used to be yours.

The stock market is a 5 day per week, public auction Ponzi scheme which continually transfers real wealth from one person to another.

Marilyn, at whose feet I am not worthy to kneel, got this one wrong.

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