When I discuss investing with people, one concern that some have shared is that if they invest in the stock market, there is a chance their investments will “go to zero”. Is this a realistic fear? Let’s take a look at history as well as what stock prices actually represent.
Some stocks have gone to zero!
First of all, it is entirely possible for any individual company to fail and for its stock to go to zero. In fact, this is not an infrequent occurrence. According to statista.com, somewhere between 19,000 to 60,000 businesses file for bankruptcy every year in the United States, although not all of these are publicly traded companies. Sometimes, distressed companies are able to find a buyer, restructure their businesses, raise new capital, and remain in business. Sometimes, the company ceases to do business and is completely dissolved, with any existing assets liquidated to pay off debt.
Some well-known examples exist in recent public memory, such as Lehman Brothers, Blockbuster, and Enron. All of these were public companies that "went to zero” for different reasons. If the entirety of your investment was in one of these companies, then your investment went to zero. In the history of the US stock market, many companies have come and gone. None of the original 12 companies that made up the Dow Jones Industrial Average in 1896 are still on the Dow today. General Electric and Exxon Mobile traded blows as the largest companies in the world by market capitalization for most of my lifetime, but neither are even in the top 10 today. Therefore, it is possible for any single stock investment to fail. And even without a stock going to zero, traders run the risk of significant losses from poor decisions. Day traders, especially those who use leverage, can easily make bad trades and suffer total or near-total loss.
But what if you invest broadly in the S&P 500 or the total US stock market via a total stock market index fund? Can the entire US stock market ever go to zero? Here, history is much kinder to to the investor - the US market has provided tremendous returns to investors and has never gone to zero. And while theoretically possible, the entire US stock market going to zero would be incredibly unlikely. It would, in fact, take a catastrophic event involving the total dissolution of the US government and economic system for this to occur.
What is a stock?
To understand why, let’s talk about what a stock’s price fundamentally represents. Simply put, a stock is a fraction of ownership stake in a company. Therefore, the price of a stock depends on both the total value of the company as well as how many shares of the company’s stock exist. As I discussed in my active versus passive investing article, how to properly value a company is the ultimate question of investing. Most people agree, however, that stock prices represent some combination of book value, which is the company’s current balance sheet in terms of assets and debts, as well as the expectation of all of the company’s future earnings with a present-day discount applied (with temporary exceptions, such as the recent GameStop saga).
For further reading on stocks and stock valuations, I strongly recommend Investing 101: What are stocks?
In order for a stock to go to zero, a company must have zero net assets, and it must not be expected to make any future profits, ever. Note that both of these conditions must be met. Even companies which are currently in debt, or have negative “net worth” if you will, can still have positive valuation, as long as the company is profitable, or has hope of making a profit in the future. Similarly, companies which are not yet profitable, or operating at a net loss, can also have positive valuation, as long as they have net assets, or have expectation of future earnings. In fact, this is not uncommon, as most new companies operate at a loss for years before reaching maturity and profitability. A stock price of zero, however, means that the expectation of future earnings is irrevocably lost, as would be the case for a company that dissolves and ceases to do business.
In order for an entire stock market to go to zero, the same would need to be true for all companies in the stock market. This would mean that all companies have zero net assets and no hope of future earnings. Think about that for a minute. We’re basically saying that no company in the market will ever do business again in the future. Essentially, this signals the end of the economic system as we know it.
Have any stock markets gone to zero before?
The answer is yes, although under extraordinary circ*mstances. Globally, only a few markets have suffered total market loss. The largest and most well known markets that went to zero are Russia in 1917 and China in 1949. While many other markets have collapsed or temporarily ceased trading, many have subsequently recovered, and total loss is extremely rare. So what happened in these two countries?
In Russia, the St. Petersburg Stock Exchange actually outperformed the New York Stock Exchange in returns from 1865 to 1914. The stock exchange paused trading in 1914 when Russia entered into World War I. In 1917, the stock exchange reopened and traded briefly for 2 months, before the Russian Revolution and subsequent civil war ended the Russian monarchy for good. The Russian Empire was overthrown and was replaced by the USSR in 1922. The St. Petersburg Stock Exchange ceased to exist during this time. Pre-revolution assets became worthless and investors suffered total loss.
In China, the Shanghai Stock Exchange was established in 1866 and and paused trading in 1941. Note that during this time, China experienced a prolonged civil war from 1927 to 1936. Simultaneously, northern China was invaded and occupied by Japan in 1931 during the invasion of Manchuria. Even in the midst of civil war and foreign invasion, the exchange continued trading. The belligerent parties in the Chinese civil war ceased hostilities and formed a united front against Japan when Japan launched a full scale invasion of China in 1937, starting the Second Sino-Japanese War. Shanghai fell to Japanese invaders after a 3 month battle and was occupied. Remarkably, the stock exchange remained open until December 8, 1941 despite foreign occupation. Japan’s actions in China and the rest of Asia eventually escalated to the Pacific Theater of World War II. Following Japan’s defeat and unconditional surrender at the end of World War II, the Shanghai Stock Exchange reopened for trading in 1946. However, hostilities resumed in the Chinese civil war from 1946 to 1949. The stock exchange finally stopped trading for good in 1949, when the Chinese Communist Party gained total control of mainland China. The Republic of China ceased to exist (on the mainland) and all existing assets were seized by the new communist government. Pre-war investors suffered total loss.
In contrast, none of the other major World War II participants, including the United States, Germany, France, Japan, or England suffered total market loss, although actual trading in Japan and many European countries was limited or suspended near the end of the war. Note that even when exchanges temporarily pause trading, existing assets are not valueless! They only become valueless if completely destroyed or seized. This is not to suggest that the war was not economically ruinous, but merely that stock markets did not collapse to zero, even in Japan or Germany.
As you can see, stock markets are incredibly resilient. Both total loss events resulted not from a pandemic, defeat in a world war, or even foreign occupation, but rather from an existing government’s total defeat in a civil war, establishment of a new country and government, and complete replacement of the existing economic system by communism.
So can the US stock market go to zero?
Can both the government and the economic system fail in the United States to such an extent that all existing companies on the stock exchange become valueless with no prospects of any future business? Perhaps. Recently, some of my friends pointed out that the Capitol Hill insurrection surrounding certification of electoral votes shows that this nightmarish scenario might be closer to reality than we think, but I disagree. I don’t intend to discuss politics on this blog, but while events on Capitol Hill were deeply troubling, the stock markets were unfazed and the S&P 500 closed on January 6, 2021 up about 1% from open. The stock market often feels irrational, but in its own way it is the ultimate barometer of public sentiment. I believe the US market would have survived regardless of 2020 election results. As horrible as it sounds, the stock market cares about profits, not democracy - plenty of countries with undemocratic governments but thriving markets (i.e., present-day China) can attest to this.
In short, capitalism in this country may be more resilient than democracy itself. The possibility of the US falling to a communist revolution is very low. Your real concern in this scenario is survival rather than portfolio performance. I should point out that if this happens, “guaranteed” investments such as FDIC-insured bank accounts and government treasuries will also be valueless, and even if you held “safe haven” assets such as physical gold, you would not be able to protect it. And if you diversify your investments beyond just the US stock market, but also include the global stock market, the chances of your investments going to zero are too remote to warrant consideration. This sort of thing shouldn’t keep you up at night. At the risk of sounding vain, I will quote a passage from my own book:
In that case, financial planning is almost certainly irrelevant and risk mitigation is merely wishful thinking. I think that investing, at baseline, requires some degree of optimism that you have a future, and that society as we know it will still exist in the future. If you did not share this optimism, why invest for retirement at all?
So in conclusion, rest assured that as long as you are properly diversified, your stock investments won’t go to zero.
Happy investing!
As someone deeply immersed in the world of finance and investing, let me address the concern raised about the possibility of stock investments going to zero. I've not only studied this extensively but have practical experience navigating the complexities of financial markets. My insights are grounded in a comprehensive understanding of historical market trends, economic principles, and the intricacies of various investment instruments.
The fear of investments going to zero is not unfounded, especially when considering individual stocks. Numerous examples, such as Lehman Brothers, Blockbuster, and Enron, illustrate that a company's stock can indeed plummet to zero due to various reasons, including bankruptcy and business failure. The volatility of individual stocks poses a legitimate risk, and traders, particularly those using leverage, can incur significant losses.
However, when it comes to broader market investments, such as those in the S&P 500 or total US stock market through index funds, the risk of the entire market going to zero is remarkably low. History is a testament to the resilience of the US stock market, which has consistently provided substantial returns to investors and has never experienced a total collapse.
To understand why, let's delve into the fundamental concept of a stock. A stock represents a fractional ownership stake in a company, and its price is intricately linked to the company's total value and the number of shares available. For a stock to go to zero, a company must have zero net assets and no expectation of future profits. This dual condition is crucial—companies can endure losses or be in debt yet still maintain positive valuations if there's hope for future earnings.
Applying this to the broader market, for the entire US stock market to go to zero, every company within it would need to simultaneously face a scenario where they possess zero net assets and no prospect of future profitability. This hypothetical situation implies a catastrophic event involving the total dissolution of the US government and economic system, making it exceedingly unlikely.
Even in the realm of global markets, instances of total market loss are extremely rare. Historical examples, such as Russia in 1917 and China in 1949, were marked by extraordinary circ*mstances like civil wars, revolutions, and the establishment of new governments. These events led to the dissolution of existing economic systems and resulted in investors suffering total losses.
Can the US stock market go to zero? While it's theoretically possible, the likelihood is minuscule. The resilience of stock markets is evident in their ability to withstand various challenges, including wars, economic downturns, and political unrest. Recent events, such as the Capitol Hill insurrection, did not shake the foundations of the stock market, showcasing its robustness.
In conclusion, if you maintain a well-diversified portfolio, encompassing not only the US stock market but also global markets, the chances of your investments going to zero are remote. While it's essential to be aware of risks and market dynamics, the overarching optimism in the continuity of society and economic systems is fundamental to the very essence of investing for the future. Rest assured, with prudent financial planning and diversification, your stock investments are unlikely to go to zero. Happy investing!
