If you’ve ever been serious about saving for something big like college tuition or retirement, chances are you understand the multiplying effect the market can have on your money. However, knowing where to put your money and understanding how the market works…that’s a different story.
Here are a few key terms you may have heard before: Dow. NASDAQ. S&P 500. Fear index. NYSE. Commodity prices. Earnings. Economic indicators.
These are critical terms for investing, but if you stopped most people on the street, you’ll find they have only a hazy understanding of what these terms mean. So here’s a quick guide to some of the basics.
THE MAJOR U.S. INDICES.
Dow Jones Industrial Average – Tracks how 30 publicly owned companies trade on a market day– the “blue chips”, 30 titans of U.S. and global business chosen by the Wall Street Journal, most not actually industrial.
NASDAQ Composite – Records the performance of 3,000+ companies on the NASDAQ Stock Market (see below), including many technology firms.
S&P 500 – Logs the performance of 500 leading publicly traded companies across ten different sectors (business/industry categories), as determined by financial research giant Standard & Poor’s (there was actually a Mr. Poor, hence the name).
At the end of the trading day, these indices settle or “close” at a price level.
The Dow is a price-weighted index – that is, its value each trading day rides up or down on the price movements of its 30 components.
By contrast, the S&P 500 and NASDAQ (and most other stock indices) are cap-weighted, meaning the index value reflects the total market value of the companies in the index and not simply the prices of individual components. The S&P 500 has both a price return and a total return (the total return includes dividends).
WHAT TO PAY ATTENTION TO
While the nightly news tells everyone what the Dow did today, many seasoned investors pay more attention to the S&P 500, which represents about 70% of the value of the U.S. stock market. There are other indices that also grab Wall Street’s attention.
Russell 2000 – Lists the “small caps”, which are usually newer and younger firms than found in the predominantly “large-cap” S&P 500.
Wilshire 5000 – Tracks stocks of almost every publicly owned company in America (6,000+ components).
CBOE VIX (Chicago Board Options Exchange Volatility Index) – Also known as the “fear index,” it measures investors’ expectations of volatility (read: market risk) in the S&P 500 for the next 30 days.
THE STOCK EXCHANGES
Stocks trade on exchanges, with the most prominent in America being the New York Stock Exchange (NYSE), the “big board” at which celebrities are seen ringing the opening or closing bell. Other notable U.S. stock and securities markets include the American Stock Exchange (AMEX), the CBOE and the NASDAQ Stock Market.
THE BOND MARKET
Further decentralized trading occurs here, conducted by institutional and individual investors, governments and traders buying, selling and issuing government, corporate and mortgage-linked securities (and other varieties). Bond prices fall when bond yields rise, and vice versa. Interest rate changes affect the bond market more than any other factor; credit rating adjustments and changes in the appetite for risk (i.e., a race to or retreat from stocks by investors) can also play roles.
What moves the markets up and down? Information – or more precisely, the way large institutional investors respond to it. Things really move when the equilibrium of the market is upset by either positive or negative breaking news – it could be a geopolitical development, a natural disaster, a central bank decision, a comment from a Federal Reserve official or the Treasury Secretary, it could be many things. It could be earnings reports – corporate earnings are sometimes called the “mother’s milk” of stocks, and when two or three big companies beat estimates, Wall Street may see big gains that day.
The markets also respond to an ongoing stream of economic news releases from the federal government and other organizations, such as:
- Federal Reserve policy announcements (interest rate adjustments, the implementation or cessation of stimulus efforts)
- Labor Department’s monthly employment report finishes
- Commerce Department’s consumer spending report
- Bureau of Labor Statistics Consumer Price Index measuring consumer inflation
- Monthly reports on existing home sales (from the National Association of Realtors)
- New home sales (from the Census Bureau)
- Home values (via the S&P/Case-Shiller Home Price Index)
Although it can be very helpful to have a basic understanding of the markets, you don’t have to navigate them alone. Partnering with a Certified Financial Planner that you trust who has a constant eye on the markets can help you make significant progress toward achieving your financial goals in the long-term.
Julie Newcomb, a Certified Financial Planner™ in Orange County, CA, specializes in financial planning for women. As a wife, mom and business owner, Julie understands the pressures and challenges most women feel on a daily basis as they juggle many important priorities. Julie’s favorite thing about her job is the ability to give women peace of mind when they entrust her with their finances. To learn more about Julie Newcomb Financial, go to julienewcomb.com.