- Your portfolio can be impacted by overall economic conditions, no matter which assets you hold in it
- You don’t need to be an economist to start investing, but knowing some key terms will help you decipher the news
When you’re investing, you’re putting your money into the market.
You might be doing it using stocks, bonds, ETFs, or mutual funds, but no matter which investments you’ve chosen, one thing is always going to be true: your portfolio’s performance can be impacted by the market at large.
That’s why it’s important to understand the terminology people use to talk about (and report on) the market, not to mention the economic factors that can have a big impact on it.
Instead of trying to muddle your way through news reports and office water-cooler chatter about the economy, here’s an overview of the key terms and phrases you’ll need to know.
Stock Market Indices
Usually, when people report on “the market,” they’re actually referring to a subset of the market represented by a market index that tracks a smaller group of stocks.
There are three that you’ll hear often in this context: The Dow Jones, the S&P 500, and the NASDAQ Index.
When you hear people say the market is down a certain number of points, they’re usually referring to the Dow Jones being down a certain number of points.
However, this isn’t a great way to measure the overall market, because the Dow Jones only represents 30 of the largest companies in the United States.
The S&P 500 is a better way to represent the overall market, simply because it represents 500 stocks in the US, not just 30.
Because it includes a more diverse group of companies, it gives you a better idea of the overall market’s performance.
The NASDAQ index represents every stock traded on the NASDAQ exchange, the second-largest stock exchange in the United States.
Basic Economics and Stock Market Terms
While those market indices are used to approximate the market’s performance, they’re often paired with commentary about why a specific person or news source thinks the market is doing what it’s doing.
It can be incredibly hard to pin down specific movements in the markets no matter what, but here are some of the broad factors that you’ll hear referenced because they do have a significant impact on the markets as a whole.
Gross Domestic Product (GDP)
This is the total value of all of the goods and services produced by a country.
It’s commonly used to determine the health of an economy, so when it goes up, it generally indicates the economy is doing well.
Inflation happens when the overall price of goods and services is going up, and it’s why your grandfather laments the prices in the good old days.
Some inflation is good, because it indicates that the economy is growing, but too much inflation too quickly can devalue money.
Consumer Price Index (CPI)
The consumer price index is the price of a standard basket of goods and services most people have to buy, most of the time—like food and electricity.
This metric is used as a key measure of inflation. When the CPI goes up, it indicates that prices are rising overall, aka inflation is happening.
When more people are employed, the economy is assumed to be doing better, and vice versa. That’s why unemployment is often used as a measure of the overall health of the economy.
When unemployment goes down, it’s a good sign, and when it goes up (like during the recession in 2008, when it hit 10%) it’s a bad sign.
Consumer confidence is about feelings. Specifically, how people feel about the economy as a whole, and whether they think it’ll do well in the future.
When consumer confidence is high, it indicates people feel positively about the future of the economy—and are likely to spend more as a result.
Stock Market Influencers
Finally, there are some decision-makers who are big enough, and influential enough, that they can directly impact the economy as a whole.
While consumers (that’s us) can influence the economy in aggregate, our individual decisions aren’t usually news.
That’s not the case for one key market player: The Fed.
Federal Open Market Committee (The Fed)
The Fed is a government body responsible for influencing monetary policy, but while that might seem completely abstract, it means that they help to control the interest rates in the country.
They’ll raise their target interest rate to discourage lending when the economy is growing too quickly, to limit inflation.
Basically, they pump the brakes by making it more expensive to borrow money.
On the other hand, if the economy is growing too slowly, they’ll lower the interest rate to make it cheaper to borrow money, with a goal of stimulating the economy and helping it grow.
You Don’t Need to Be an Economist
You’ve now got a solid foundation to understand the key terms and players that impact the economy, but as with just about any subject, you could spend years learning how the economy works and all of the intricacies involved.
Luckily, you don’t need to.
While it’s important to know the basics, that’s really all an everyday investor needs to understand, especially since trying to predict what the market and the economy will do in the future isn’t a good investment strategy—but more on that later.
Investing 101: Let’s do this
Investing doesn’t have to be something scary and intimidating, and it’s one of the most powerful ways you can hit your goals and build wealth over the long term.
Make a Plan:
- Should I Save or Invest?
- Understanding the Stock Market
- Long-Term Investing
- The Relationship Between Risk and Return
- Investing for Beginners
- The Benefits of Diversifying Your Investments
- Types of Asset Classes
- 5 Common Investing Mistakes