Losing all your money in the stock market is a common worry for new investors, and whilst it’s theoretically possible, it’s highly unlikely if you invest your money in a diversified way.
Human beings have a tendency towards feeling more pain when they lose money than they do joy when they make an equivalent amount.
In economics this is called the Loss Aversion Principle and it’s a real thing… it’s probably why you’ve ended up reading this post in the first place.
But are concerns about losing all your money in stocks valid?
Yes they are BUT if you think through this situation logically you’ll begin to understand why it’s not something you should be worried about.
What Are Stocks & Shares: What Are You Actually Buying?
When you invest your money into stocks you’re actually buying a small piece of a real company.
Over time the value of that company will change and that will dictate whether your share is worth more or less than when you bought it.
If you only ever put your money into one company and that company goes under then yes you will lose all your money. The share value will go down to zero and will become worthless.
It happens. Companies go bust.
However… you’d be borderline insane to tie up all the money you plan on investing into the market to just one company.
Where Does Money Lost In The Stock Market Go?
When the value of a company goes down the value of your shares in that company go down with it.
But where does that money go?
Well the bad news for you is it’s already in the pocket of whoever you bought your shares from. To buy a share in any company someone must be selling a share in it. You pay them the going rate for the share, they get the money and you get the share.
How To Avoid Losing Money In The Stock Market
The simple answer to this question is diversify when you make investments.
This means that instead of putting all your money into just one company, which could legitimately go under and see you lose all your hard earned cash, you put your money into a range of different companies, and even asset classes, instead.
Asset classes: there are many asset classes including commodities such as oil and gas, metals like silver and gold, real estate and company shares.
How do you do it?
Well if you invest though a financial advisor they’ll automatically do this for you by recommending you buy into an investment fund which is externally managed.
This fund (usually called a managed portfolio or mutual fund) will pool millions of pounds from thousands of investors together and buy small pieces of hundreds of companies all over the world along with allocation an amount of the fund to other various asset classes.
Similarly if you buy an index fund, which is my preferred method of investing and you can do yourself online, you’ll be buying into hundreds of companies and spreading your risk across all of them.
You can then buy ETF’s (exchange traded funds) which track the price of other commodities if you want addtional diversification.
Now for you to lose all your money you’d need hundreds of different companies to go under, not just one, and that’s where losing all your money becomes highly unlikely.
Plus if it did happen I can guarantee there’d be more to worry about than the money you’d lost.
We’re talking aliens invading here or a total economic meltdown where we’d all be back living in caves and hunting with spears for our dinner.
What About Stock Market Crashes? Or a Total Crash Even?
History has taught us that at some point in time the stock market will inevitably crash. The likelihood is it’s already happened in your lifetime more than once, to varying degrees, and it’s going to happen again.
In 1929 the market crashed 25%, in 2008 it crashed 34% and in 2020 at the outset of the covid-19 pandemic it crashed 29% in a week.
Each time though, it’s recovered and reached a subsequent new high point – at the time of writing the FTSE 100 (index of top 100 UK companies) still has a little way to go to do this but the S&P500 (index of top 500 US companies) has already breached it’s previous high point and we’re currently in our third Covid-19 lockdown.
The lesson here is if you don’t panic sell when the market goes down and instead wait it out you’ll be rewarded for your patience. You won’t lose all your money… you’ll end up with more.
What about a total crash? Could that happen?
I suppose it technically could happen but you’ve got to remember what you’re buying when you buy stocks and shares.
It’s a small piece of ownership over a real business.
As long as that business continues to operate there won’t be a total crash. The world needs these businesses to function and without them people won’t have a roof over their head, electricity, oil, gas, food, water… the list goes on.
In a total crash situation your money is as worthless in the bank as it is in the stock market (aside from using it get that fire in your newly decorated cave going of course).
Remember: if your money is sat in the bank doing nothing then over time, either inflation or deflation, will render it worth less than and less every year. It’s not that the amount goes down it’s just that the spending power reduces which is effectively the same thing.