On my drive to work this morning, the radio played the Dow Jones report as usual. It occured to me that, though I’ve heard about the SNP 500 and the Dow roughly 15 million times, I have absolutely no idea what any of it means. And I don’t think I’m alone in this. It got me thinking: How many Americans actually own stock? Would the economy be better if more people owned stock? How does the Dow Jones affect my life? Should I care more about it? Any thoughts, fellow Dopers?
Google, “number americans own stock”.
Either 22% or 55%, depending on whether you’re including stock funds
[shrug]
If you have a 401K or similar plan and invest in mutual funds.
If you are vested in an employer-funded pension plan that invests in stocks or funds.
If you have an insurance policy with a company that invests in stocks.
If you have a corporate (not federally insured) certificate of deposit or money market fund backed by public companies.
These are a few of the examples I can think of where the Dow or S&P 500 swings could affect your financial situation.
It’s not such a mysterious subject.
When a company wants money, one option is to offer people a gamble that goes like this: 'We think we’re going to do really well and make some good profits. If you give us some money up front, at the end of the year we’ll give you a share in the profits we expect to make".
Example. At the most recent LonDope, the delightful Fierra and the stylish Tansu decided they were going to start a new company that will manufacture “Cleavage Beer” and build pubs and bars to sell it in, under the Cleavage Beer name.
If they don’t have any ‘working capital’, such as a couple of million lying around, they can either borrow the money (e.g. from rich friends or a bank) or thay can offer shares in the company. To keep it simple, let’s suppose they sell exactly 100 shares at 1000 pounds/dollars each. Let’s say I buy 50, you burundi buy 40 and Cecil buys 10.
Tansu and Fierra set the business up and at the end of the year they’ve made 250k pounds/dollars profit. They keep 50k back to plough back into the business, and declare 200k as the ‘dividend’, the amount to be given back to the shareholders. There are 100 shares in all, so each share = (200k / 100) 2k. I have 50 shares, so I get (50 x 2k) 100k. I invested 50k, and got 100k back, because I bought the shares when they were worth 1k, and then they went up in value and are worth 2k each.
These are silly numbers, but they suffice to explain the principle. Also, for the sake of keeping it simple, imagine that buying ‘stock’ is pretty much the same deal as buying ‘shares’ - you pay some money up front on the expectation that the company will do well and you’ll eventually get more money out than you put in.
I can either redeem the value of my shares and turn them into cash (by selling them to anyone who wants them) or I can keep them (on the expectation that their value will continue to go UP, so they will be worth even more later on).
If CleavageBeer isn’t very popular, or if F and T don’t run the business very well, then the profits will be much lower, so the dividend will be lower, so the value fo the shares will be lower. It’s possible for shares to be worth LESS than the original purchase price, in which case the investors have made a loss, instead of making a profit.
Shares obey the law of supply and demand. If lots of people think a company’s shares are worth having, their price goes up. If not many people want them, they are hard to sell and their price goes down.
What makes the whole thing fun and interesting is that the entire stock market system runs of vague aspects of human psychology and emotion, including some self-fulfilling cycles. If there is a general feeling of optimism about the economy, and about the health of the stock market, ordinary people (like you and me) are more inclined to buy stocks and shares. So there’s plenty of investment money sloshing around, which makes it easier for entrepreneurs to get new companies off the ground, and for established companies to expand and grow. So there are new businesses, new jobs, more people in employment, fewer people on welfare, the nation is producing more, and this means the general mood is good… and the cycle goes around once more.
On the other hand, some things can cause investors to lose confidence in the market. If there are political or economic problems, and people think the economy is not being very well-run, they can lose confidence in the ‘risky’ sotck market and tend to put their money somewhere that yields less profit, but is safer (such as a savings account). Likewise, if lots of irregularities and scandals come out (Enron, Worldcom etc.) then this can dent people’s faith in the ‘fairness’ and ‘integrity’ of the market, so again they tend to avoid buying shares. Which means less investment money formcompanies to play with. So fewer new companies, fewer jobs, more depression, more people on welfare and so on. Which tends to lead to a gloomy, pessimistic mood, which tends to deflate confidence in the stock market… and round the cycle goes again.
Does it matter how many people are willing to invest on the stock market? Yes, of course. Selling shares is a major part of how entrepreneours get new businesses off the ground, and how established companies get fresh funds to expand and grow.
What do all those pages of financial reports tell you? Well, the reports about a specific company tell you a lot about the prevailing mood or attitude towards that company and its business - whether people think it’s a good short or long-term bet, whether it’s being well-run or has good products.
But you can also lump together a lot of different companies, and track their total share value over a period of time. This is what the general indexes do (the Dow Jones in America, the FT-SE or ‘Footise’ here in London, and there are others). These give you a sort of ‘averaged’ picture of shareholder confidence and people’s feelings about the economy, rather than just looking at the performance of one particular company.
For example, if a new government is elected, and there is a general feeling that the new guys won’t be very good at running the economy, then this can lead to a view that it will be hard for companies to do well and make decent profits, so investors lose confidence and start selling shares and the index goes down.
It’s actually quite interesting when you get into it! Sometimes, small events can have massive effects on the state of the economy and on share prices. People who try to make money on the stock market try to make the very best guesses and judgements they can about whether certain shares are going to go up or down, based on the best analysis and information, or based on ‘gut’ instinct! Those who get it right can make a lot of money very quickly by buying shares when they are low-priced and selling them when they are valued more highly. Those who get it wrong (buy high, sell low) will lose money equally quickly!
- There are well over 5000 publicly traded companies. Of that number, 30 make up the Dow Jones Industrial average. Those stocks are chosen by certain editors of the Wall Street Journal for somewhat obscure reasons.
Professional investors prefer the S&P 500 as an indicator for the US stock market. News reports that highlight the Dow also reveal the superficiality of their analysis.
- In 1995, the richest 1% of the population owned about half of all stocks and mutual funds. The richest 10% owned 88%. (Field Guide to US Economy).
So although lots of people have some exposure to the stock market, the Dow’s ups and downs have disproportionate effects on a slim minority.
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Housing wealth exceeds household mutual fund wealth. (Mut fund 1994=$969 bill; Owner occupied residential structures 1993=$4164 bill) Source: Stat. Abstract.
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Companies raise lots of money on the bond market, though that doesn’t get as much media play.
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The media overemphasizes the Dow, IMHO, because it is easy to assemble a superficial report on “Wall Street” and because there’s something hypnotic about the minute-by-minute movements of various stock market averages. Sort of like putting a window on a front-loading washer. Fascinating, but not especially informative.
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Does the Dow matter for the economy? Only indirectly. There are better ways of measuring an economy’s performance or prospects.
I apologize in advance for this post…
[Jeff Foxworthy voice]…you may be a stockholder.[/Jeff Foxworthy voice]
I apologize once again. I just couldn’t help myself…