A reader wrote to me: “After your recent article about the big questions for 2018, I was astounded that ‘only 54 percent of Americans report having money invested in the stock market at all.’ Does that mean that all of the attention we put on the stock market is misplaced? Are we putting too much focus on stocks?”
Because so many of you responded to that statistic, it probably means it’s time for a primer-refresher on just what the stock market and the various stock market indexes really tell us.
When you buy a stock, you are placing a bet on a company’s ability to generate earnings in the future, which in turn would propel the price of the stock higher. In addition to that capital appreciation, you may also earn money from stock ownership in the form of dividends, which come when the company distributes some of its earnings to stockholders. That income can be especially important for future retirees.
But the larger reason why many of us invest in the stock market is to help grow our money faster than the rate of inflation. Over time, we have learned, a diversified portfolio of stocks, bonds, a sprinkling of real estate or other commodities and cash, can deliver long-term returns that will do just that.
When the economy is strong, it stands to reason that companies will perform better, but there are also cases in which the stock market and the economy diverge. This happens because other factors affect stock prices, such as interest rates (monetary policy), government actions such as spending and taxing (fiscal policy), the rate of inflation and, of course, what’s going on at a particular company. The stars of monetary and fiscal policy have recently aligned, against a backdrop of stronger than expected global growth and low interest rates and inflation, all of which combined have had the effect of propelling corporate profits and as a result share prices.
In fact, at more than 3,200 days and counting, this is the second longest bull market for stocks on record. (A bull is defined by a period without a 20 percent decline from the recent high.) It could take time to shatter the record, held by the 1990s dot-com boom. The current bull would have to stretch well into 2021 to do so.
Before you start saying that another 3 1⁄2 years of gains is “impossible,” anything really could happen. Remember, this market has been called “the most hated bull on record,” which may be why many investors have been on guard and have even pulled money out of the market over the past five years.
While the hoopla surrounding the aging bull or index records can spook some investors, it can lure others into a false sense of security. Here’s your warning: The craziness of market records should not prompt you to either bail out of stocks or to jump in.
Market indexes simply provide us with a snapshot of how the overall stock market is doing. That means that focusing on an index does not change anything in your financial life. One way to keep you on the right path is to employ an asset allocation plan, which incorporates your risk tolerance and time horizon.
Did you just read that sentence and think, “Oh, that boring old advice again?” Yes, I am trotting out the same old advice, because it works! Too many of us are swayed by our emotions and forget that a steady hand and a good plan can help us focus on the important financial issues confronting us and our families.