What’s behind one of the most-watched economic outlook numbers?
Understanding more about how the stock market works may help you better manage what you do when you read news headlines.
If you’re like a lot of people, you may not pay much attention to daily economic indicators like gross domestic product or industrial production.
But one measure that probably influences how you think and feel about the economy is the stock market. Its ups (and downs), especially over the last few years, are often seen as indicators of our shared financial prospects and the overall economic outlook.
Here are some basics.
How are the “markets” defined?
Dow Jones, S&P 500, NASDAQ, NYSE: Those are perhaps the most quoted by the media, but they’re not all representative of the same things. Major economic centers around the world have their own stock and bond market exchanges. For example, in the U.S., the New York Stock Exchange (NYSE) is one of the country’s stock markets, where buyers and sellers of shares of company stocks trade their holdings with one another. There are exchanges that are digital where buying and selling securities is done on a fast, computerized, transparent system, like the NASDAQ.
And then there are indices. The Dow Jones and S&P 500 are two of the most common, which track a group of stocks as a portion of the broader market. Bonds, where investors can buy and sell debt securities issued by companies, governments, and municipalities, are also traded on exchanges and carved into indices as well.
Fact: The U.S. bond market is by far the largest in the world, making up 39% of the global market. China follows at 16%.
The Dow Jones Industrial Average (DJIA), for example, is a weighted average of the stock prices of 30 U.S.-based companies. The companies that make up the Dow change over time, and so does their relative weight in the Dow's index—which is based on a company's respective market share. As a result, some companies have more market share, so they have more value in the index. If the Dow goes up in one month, that means the average stock prices of those companies in that average went up.
Indices can be sector-specific like the Dow Jones Transportation Average (DJTA), which refers to 20 transportation sector companies such as trucking and airlines, or they can represent the size of a group of securities like the Wilshire 5000, which tracks the performance of the total U.S. stock market.
Japan has the Nikkei 225 Index, which trades on the Tokyo Stock Market Exchange, and Germany has the DAX (a 40-company index) which trades on the Frankfurt Stock Exchange. “Indices are all just different ways of slicing and dicing investment opportunities around the world and here in the U.S.,” says Heather Winston, financial professional and product director for retirement income solutions at Principal®.
| Stock market vocab cheat sheet | |
|---|---|
| Stock | Ownership claim of a company (private or public) |
| Stock market or exchange | Collection of public stock buyers and sellers such as the New York Stock Exchange (NYSE) |
| Stock index | A measurement of a group of public stocks (the DJIA, for example) |
| Investment fund (mutual fund, exchange-traded fund, etc.) | Pooled money used to collectively invest in a diversified portfolio managed by professionals |
Why do company stock prices change?
At any point in time, some companies are on an upswing and some are on a downswing. “When you see that a market or index had a positive day, that means there were more buyers than sellers,” Winston says. “If the overall direction is positive, then the market as a whole goes up.”
In a stock index, you’ll find a similar mix of companies—some doing well, others facing challenges. Because an index involves more than one company or bond issuer, the opportunity for growth is spread around.
Will the stock market always go up?
From day-to-day, prices of securities (both stocks and bonds) fluctuate based on supply and demand from buyers and sellers. That’s why financial professionals usually suggest focusing on long-term investing, especially for retirement, as it helps reduce some of the risks linked to sudden market fluctuations.
Quick, daily moves in (and out) of investments and savings plans can disrupt overall financial goals. “The stock market won’t always go up, but none of us can predict when trends will change course,” Winston says.
Your retirement savings, which are typically invested in various funds and indexes that are bought and sold on stock markets, may be impacted by big swings. But over time, those swings tend to even out.
That’s why slowly and steadily building your retirement savings—even deferring 1% more every year—can make a real impact.
“Most of us will spend nearly as many years in retirement as we did saving for it. If you keep that in mind and invest in alignment with your risk tolerance, you may see the most potential to grow your savings to help achieve your goals,” Winston says. “Generally, as you’re nearing retirement, you’ll want to apply a more cautious investment strategy to protect your savings from market volatility.”
3,700
The number of publicly traded U.S. companies
What do the experts know about the markets?
Sometimes the markets don’t react much, whether the news is good or bad. That’s because the professionals managing funds and indexes on these markets spend all day, every day, assessing the health of companies, sectors, and the like. Not only do they do it daily, but they track and analyze the data over extended periods, not just days or weeks, but months and years.
Understanding the ins and outs of the stock market, as well as the health of individual companies and sectors, can be challenging, especially if you lack the time, knowledge, and interest required for ongoing, in-depth analysis.
“As individuals we don’t have much impact on the market because we invest in small quantities, relatively speaking,” Winston says. “It’s really in professional trading where large blocks of shares are being bought and sold that typically move markets.”
What’s next?
Are you saving enough to accomplish all your retirement goals? to find out. Don’t have an employer-sponsored retirement account or want to save even more? We can help you set up your retirement savings with an individual retirement account (IRA).
