Over the last few months, many big names like Elon Musk, Jeff Bezos, and Larry
Page have been losing a lot of money. Large companies like FTX and Uber are
suffering heavy losses as well. Obviously, this happens from time to time, due to
the nature of the market. However, the big question is “Where do these losses end
up?” When you look at all these losses in total, there are hundreds of billions of
dollars unaccounted for.
Since the value of these big names is attached to the stock market, these are
known as “paper losses.” Their net worth is not due to them losing money, but
rather the value of their holdings decreasing. If you had 1,000 shares of a stock and
each stock is worth $500, you have a net worth of $500,000 (assuming you have no
other forms of income or debt). If that share price goes down from $500 to $400,
then your net worth goes down to $400,000. You technically haven’t lost any
money (yet), but if you wanted to sell those shares, you would make less money
than you could have. The loss essentially exists in a state of limbo where the stock
value may or may not recover itself. Therefore, it is impossible to apply a fixed
value to these losses.
It mainly boils down to a matter of realized vs unrealized losses. We call them
paper losses because that is how they exist, “on paper.” Once the shares are sold,
the loss becomes realized and is no longer a paper loss. Since paper losses are
unrealized, some investors are less likely to care about them, given that there’s a
chance for the loss in value to bounce back. Patient investors are more likely to
hold in the hopes that they can recover their losses.
In certain situations, it makes sense to sell at a loss. If you have other investments
that are doing well, the capital losses can balance out the capital gains. The IRS
does not take paper losses into consideration since you haven’t lost any actual
money. Therefore, you would need to realize those paper losses in order to lessen
the tax burden from your capital gains. Turning investment losses into tax breaks is
a common strategy that people utilize to alleviate a lot of pressure around tax
season. It is typically more useful for individual stocks rather than ETFs or mutual
funds.
One of the biggest misconceptions about wealth is that it cannot be created nor
destroyed, similar to the law of conservation of energy. Anyone can create, destroy,
or transfer wealth. Wealth can go up or down due to economic growth/decline. As
time moves forward, it becomes easier to obtain resources and come up with more
efficient ways to utilize those resources. There are all kinds of new machines and
software that significantly increase the ratio of productivity to human labor. On the
other hand, you have things like stock market crashes and supply chain disruptions
which can lead to recession.
Since this is the case, there’s no actual guarantee that the “big money” must end
up anywhere. There is no rule that suggests that investment losses have to transfer
anywhere else. Does that mean the money is missing? Not exactly. It’s more like the
money was never there to begin with. When the money lies within the stock
market, the value only exists as an unrealized potential of itself and does not exist
outside of that. There are also all kinds of loans and debt that go around and
function as real money. When a borrower doesn’t pay their loans, it leads to a
default. Defaulting essentially wipes the loan from the balance sheets.
When a recession happens, people have less money to spend and invest. Banks are
also less likely to loan money. Companies and individuals alike try their hardest to
hold onto every dollar they can. Under normal circumstances, money changes
hands frequently throughout the day, due to all the exchanges of goods and
services. This slows down a lot during a recession, which means there’s less
available money. The company’s performance is what creates a stock’s perceived
value. During a recession, people are less willing to trade money for most stocks
which results in a depreciation of value.
It’s sort of like having a trading card. Let’s say you are the only one who as it, so
everybody wants it. You start to hear offers starting at $10, eventually going all the
way up to $200. Then suddenly, more people start getting the same trading card
you have. At this point, you might have a hard time trying to find someone willing
to pay you $20 for the card. You didn’t necessarily lose $180. You simply lost an
opportunity to acquire that money.
Net worth is very similar. The vast majority of ultra-high-net-worth individuals
(people with a net worth of $30 million or higher) have most of their worth tied to
the stock market. It’s a perceived value that can go up or down at any time. When
the net worth of an individual decreases, it does not necessarily mean that they
lost money or that it went anywhere. It can simply be a decrease in the value of
their assets. Society’s belief in economic growth is the biggest reason it is able to
function today. If that belief were to disappear, the economy would crumble.
