The Market Is Not the Economy, but It’s Still Important
Ethan Miller, Financial Planner
February 4, 2018
If, like me, you’re a fan of Marketplace and its host Kai Ryssdal, you’ll be familiar with his often-repeated mantra about the stock market, “the market is not the economy and the economy is not the market.” This has become even more clear over the last few years, as record corporate profits and business-friendly legislation like the tax reform bill have pushed the stock market indices to record numbers, even as wages and the labor force participation rate remain low.
Now, with last week’s substantial drop in the stock market prompting many to repeat Mr. Ryssdal to calm their nerves, you might be wondering: if the stock market doesn’t represent the economy, why does it matter?
First, let’s start with a basic overview of various measures of the stock market. The numbers you’ll most often hear reported on are the Dow Jones Industrial Average ( or, “The Dow”), the Nasdaq Composite (often, just Nasdaq) and the S&P 500 index (commonly called the S&P). All three have measure different parts of the stock market in different ways, but it is commonly accepted that the S&P 500 index is the most accurate representation of the general health of the US Stock Market. The Dow, while it often makes the biggest headlines, represents the stocks of just 30 companies and is a poor representation of the market as a whole, due to its use of price-weighting instead of capitalization-weighting.
Second, though rising income inequality has lead to a disconnect between wages and stock prices over the last few years, there are many indicators that are still closely linked to the stock market, such as unemployment, inflation and retail sales. That’s not to say that daily movements in the stock market can be explained by any one jobs report or quarterly report, but in the long-term, these factors are linked.
So why does this matter to you? If you’re looking towards your future and are starting to save for retirement, it’s likely that you’ll invest a portion of funds from your 401(k), IRA or Roth IRA in stock mutual funds. Though sudden drops can be concerning, in the long-term, the stock market has a record of returning consistent gains that are needed in order to maximize the impact of compound interest.
While those with shorter-term savings goals (less than 5 years) shouldn’t look to the stock market to stash their cash, as you continue to grow your long term savings, it’s important to understand what you are investing in. And while the market should not be your only indicator of the health of the economy, market moves have an impact on over half of all Americans. But if you’re looking to gague how the other half of the country is faring, you’ll have to look somewhere else.
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