Buying a Stock, Where Does the Money Go? | EDGE Investments (2024)

Most know that investing their money in the stock market is one of the most effective ways to build significant wealth.

However, many don’t know what exactly happens when they buy a stock and where their money goes after pressing the “buy” button in their brokerage account.

Why does understanding where your money goes when you buy a stock matter?

Well, finding success in the stock market relies heavily on investors being properly educated on important financial topics, so they can make more informed and strategic decisions with their money.

Before we look at what happens when you buy a stock, let’s first set a good foundation on the basics of stock market investing.

What is a Stock?

A stock is a security that represents ownership in a company. Units of stock are called shares and entitle shareholders (the individuals that own shares) a right to a portion of the profits from a company.

Companies are able to sell shares to investors by partaking in an initial public offering, which puts their stock on major stock exchanges. Once successfully listed on a stock exchange, investors can then buy and sell shares as they wish.

What is the Stock Market?

The stock market is a marketplace (much like a flea market or farmers’ market) where buyers and sellers come together.

Investors purchase shares on a stock exchange in hopes the value of their shares will rise in value over time. And companies issue their shares on stock exchanges to raise the capital they need to fund further growth initiatives.

The stock market provides value to both the investors buying and selling shares, as well as the companies who choose to make their shares publicly available.

How Do I Invest in Stocks?

Investing in stocks has become much easier within the last 20 years. Whereas before, investors had to call a broker who would then place a trade for them and rely on paper copies of a stock certificate to prove ownership. Now, buying and selling stocks happens almost exclusively digitally, with major financial institutions providing online portals where investors have instant access to stock markets and asset prices.

To begin investing in stocks, one should reach out to their bank or other financial institution to set up a cash account. Once approved, investors will be able to transfer money into their trading account and begin to buy, sell, and trade stocks, as well as other financial assets as they wish.

Why is it a Good Idea to Own Stocks?

Without question, investing in the stock market is one of the most effective and simplest ways for individuals to build wealth over time.

The chart below shows the total return of the S&P 500 dating back to the 1930s.

Clearly, the returns in any given year vary considerably, and overall market volatility is something investors must cope with, though, in the long term, the average annualized return of the S&P 500 is between 8-10%. Meaning investing in the stock market is an incredible way for individuals to build lasting wealth.

Further, owning stocks means you’re entitled to a share of a company’s profit, which a company may distribute to shareholders if they decide to pay dividends.

Additionally, when comparing stocks to other asset classes, the argument to invest in stocks becomes even stronger. The chart below shows the annual return between different asset classes investors can choose to invest in. Looking at total returns between 1985 and 2022, investing in large cap stocks (with a return of 8.0%), emerging market stocks (with a return of 7.3%), and small cap stocks (also with a return of 7.3%), provided the highest returns for investors.

Other asset classes, such as international bonds, gold, and cash, all provided annualized returns of less than 2.5%.

Clearly, investing in stocks is the most efficient way for investors to secure a high return on their hard-earned money. More specifically, stocks also outperform other asset classes, such as gold or government-issued bonds, and will allow investors to achieve an average return between 8-10% per year.

Now that we have a better understanding of some stock market basics, let’s begin to explore what exactly happens when you buy a stock and where your money goes.

Where Does My Money Go When I Buy a Stock?

Where your money goes when you buy a stock first depends on whether you’re buying shares on the primary or secondary market.

Primary Market

Primary markets are reserved solely for companies that are entering public financial markets through an initial public offering (IPO).

On primary markets, those who purchase shares are directly paying the company in order to receive common stock (or a partial ownership stake) of the business.

The price of a share and quantity issued are set by the company and partnering investment bank ahead of time.

Companies use IPOs to raise money and achieve large cash infusions that they will use to hire new employees, build new facilities, develop new products, or anything else they need in order to continue growing their business.

In short, primary markets are reserved for companies making the transition from privately owned businesses to publicly traded entities. Investors are willing to buy shares with the expectations their shares will be worth more in the future, and companies aim to enter public markets to gain access to the large amounts of capital they can raise through issuing shares.

Secondary Market

After a company successfully issues shares through an IPO, those shares are then transferred to the secondary market.

Secondary markets are what most people think of when they picture the stock market and are where investors buy and sell shares with other investors. Stock exchanges like the New York Stock Exchange are home to many stocks and are where both individual investors and large institutional investors (such as mutual funds) buy stocks.

In primary markets, when you buy shares of a company, your money goes directly to the company. However, in secondary markets, when shares are purchased, the money goes directly to the seller.

Further, stock prices are determined through the supply and demand of shares, and a specific market maker provides the marketplace for buyers and sellers to make transactions.

Where Does My Money Go When a Stock Goes Down?

The short answer to the question of where your money goes when a stock goes down is that it simply disappears. When this happens it is known as wealth destruction.

To better understand where your money goes when a stock goes down, let’s compare buying a stock to buying a house.

When you buy a house and that house goes down in value, where has that money gone? It hasn’t been redistributed to other investors. Rather, the value of your investment has gone down, meaning it is now worth less should you decide to sell it.

Buying stocks and watching the price go down leads to the same outcome. When a stock falls, the value of the asset is reduced, and when you decide to sell that asset, you will have less money than you originally paid for it.

Simply put, when you buy a stock whose price goes down, your money has unfortunately gone into an asset that has depreciated in value. Investors may choose to sell this investment in order to limit their losses or continue to hold in hopes the asset may once again reach a higher price.

In Conclusion

By buying shares offered by successful companies, you’ll become entitled to a slice of the company’s profits. Companies may choose to redistribute this profit to shareholders through dividend payments or use this money to help grow the business further.

When you buy stock on the primary market, your money goes directly to the company that is executing their initial stock offering. A company enters the open market for the large amount of capital it can raise to help fund growth and other initiatives. Alternatively, when an investor buys a stock on the secondary market, their money goes to the seller in exchange for shares.

Overall, investing in the stock market can provide a lucrative opportunity for individuals seeking to build long-term wealth. With careful research, a sound investment strategy, and proper education, the stock market can be a valuable tool for achieving financial success.

Disclosure/Disclaimer:

We are not brokers, investment, or financial advisers; you should not rely on the information herein as investment advice. If you are seeking personalized investment advice, please contact a qualified and registered broker, investment adviser, or financial adviser. You should not make any investment decisions based on our communications. Our stock profiles are intended to highlight certain companies for YOUR further investigation; they are NOT recommendations. The securities issued by the companies we profile should be considered high risk and, if you do invest, you may lose your entire investment. Please do your own research before investing, including reading the companies’ public filings, press releases, and risk disclosures. The company provided information in this profile, extracted from public filings, company websites, and other publicly available sources. We believe the sources and information are accurate and reliable but we cannot guarantee it. The commentary and opinions in this article are our own, so please do your own research.

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