When You Buy a Stock, Where Does the Money Go? [The Facts]


In the modern world of mobile investing, you can swipe your thumb and purchase shares of stock in a matter of seconds. While this is more than convenient, some financially conservative people may feel like their money is disappearing into thin air. So when you buy a stock, where does the money go?

When you buy a stock, the money goes to the seller who is listing the stock on the secondary exchange. Outside of the IPO, the issuing company does not receive money from stock sales.

It is easy to think of the secondary market as a giant flea market for stocks, a network of millions of buyers and sellers trading previously-purchased goods. To understand exactly how all of this works, keep reading for a detailed breakdown of where your money goes when you buy a stock!

When You Buy a Stock Where Does The Money Go?

Unless you participate in an initial public offering (IPO), the money you spend to purchase shares of the stock goes to the seller of the stock–not the company that issued the stock. 

In most circumstances, IPOs will take between three to nine months from initiation to completion, so when you buy shares of the stock after this timeframe, you will be purchasing them on what is known as the secondary market.

Once the stock reaches the secondary market, it is no longer the sole property of the issuing company. Its purpose as a fundraising mechanism is effectively over once the IPO is complete, and the shares serve as a vehicle for creating wealth for those on the secondary market. 

The secondary market is filled with millions of buyers and sellers. The stock exchanges (Dow Jones, NASDAQ, S&P 500, etc.) list the stocks for sale. To transact the stocks, there are millions of investment banks and brokerages through which individuals and private entities can hold accounts to participate in the market.

A Closer Look at the Secondary Market: An Example

To better illustrate how the secondary market works, let’s use the example of Nike Air Jordan sneakers.

A buyer somewhere in the world purchases a pair of Air Jordans directly from Nike. This would be similar to an IPO in the stock market, as Nike would get the proceeds from the sale.

However, the buyer has no intention of wearing these sneakers and leaves them in the original packaging because he/she wants to resell them as a collector’s item.

The owner of the Air Jordans then lists the sneakers for sale on eBay or any other resale platform. This would be similar to listing a stock for sale on one of the stock exchanges.

When you purchase the Air Jordans, the money you use goes directly to the seller who listed them on the resale platform. Nike gets none of the proceeds from this resale.

Essentially, the secondary market–where the vast majority of stocks are bought and sold–serves as a giant flea market for equities, with the private investors being the ones who send and receive the funds. The issuing company is not in the picture at this point. 

Do Companies Get the Money When Investors Buy Their Stock?

The companies only get money from their stock when it is sold during the IPO. 

During the IPO process, a group of investment banks will assess a privately held company to arrive at a valuation of what its shares should be worth on the public market. 

For easy math, let’s say that the private company wants to issue 10,000,000 shares of stock, and these shares get valued at $20 per share.

This means that the IPO can potentially bring the company $200,000,000 in funding. After the shares are sold during the IPO, the company can then use these funds to grow operations. It may want to expand into new markets, buy out competitors, increase employee salaries, etc.

However, after these shares are in the hands of the public following the IPO, the issuing company no longer receives the proceeds from subsequent sales on the secondary market. 

When I Buy Stock, Who am I Buying it From?

When you buy stock, you are buying it from a seller (most likely anonymous) on the secondary market. 

They hold stock in a brokerage account (Robinhood, Fidelity, etc.). Their brokerage is constantly scouring the stock exchanges (via an electronic communications network) to identify potential buyers. 

When you send a bid via your brokerage that meets the asking price issued by this anonymous seller, your brokerage and their brokerage work to execute the trade.

Once the trade executes, the anonymous seller gets the funds, and you are now in possession of the stock.

Who Makes Money When Selling on the Secondary Market?

If the issuing company no longer makes money when stock is sold on the secondary market, who does?

The brokers and investment bankers facilitate the stock trades between private parties.

But I thought all modern platforms followed Robinhood’s example and offer commission-free trading.

Yes and no.

In the old days, brokerages would simply charge you a fee for trading stocks. This would either be a flat fee–something like $25 per transaction–or a percentage of the total order cost. 

However, Robinhood disrupted the game with its zero-commission structure, making micro-investing affordable for even the smallest-time investors. Today, nearly every major brokerage uses a similar model.

But don’t be fooled into thinking they are working for free.

Modern commission-free platforms make their money via a process known as order flow. In a nutshell, the process works something like this:

  1. You submit a bid price to your brokerage (the price you are willing to pay for stock)
  2. Your brokerage then communicates with large-scale wholesalers
  3. The wholesalers are able to purchase the stock for a price lower than what you bid
  4. They then pass the shares on to your brokerage at a price higher than what they paid but lower than what you bid
  5. Your brokerage then sells the shares to you at the price you bid, pocketing the difference as their profit

Using this approach, both the wholesaler (investment bank) and your brokerage make a profit from the sale of stock on the secondary market. So while it is definitely more affordable than paying a commission, it is not completely free to you as a buyer in the sense that you are paying a higher price than what your intermediaries paid. 

The Bottom Line: Where Your Money Goes When You Buy a Stock

Outside of the IPO when companies issue stock to raise money, the money you use to buy a stock will go to the private seller who sold it. This type of secondary market is kind of like a giant eBay for previously purchased stocks. Also similar to eBay, your brokerage has ways of attaining their own cut–the price you will pay for their role in conveniently connecting you to sellers around the world.

Thanks for giving this a read today! We hope it was helpful!

Geek, out.

Noel

Noel is the founder and main contributor for his blog - Noel's passion for personal finance has helped him amass over 600k readers to his Financial Geek blog.

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