I recently hosted a Zoom webinar for the Lyon Township Public Library. My topic dealt with understanding today’s stock market. I talked about a number of issues driving the market today such as inflation, labor shortages, and supply chain issues.
I also talked about the importance of understanding that the stock market and the economy are two different things. The stock market does not always reflect the economy and neither does the economy always reflect the stock market.
There are a fair number of people who believe the stock market reflects the economy, but they are mistaken. A perfect example of this would have been last year. By all accounts, last year was not a very good year for our economy. Our gross domestic product, which is a measurement of all the economic activity in the country and is the true measure of the economy, fell by three-and-a-half percent.
Unemployment soared last year and even by the end of the year, there were still millions and millions of Americans unemployed. In addition, the government spent hundreds of billions of dollars in stimulus payments, and tens of thousands of small businesses closed throughout the country.
By any standard, 2020 was not a very good year for the economy.
On the other hand, the stock market had one of its best years. The Dow Jones Industrial Average showed a nearly 10 percent total return, the S&P 500 was up over 18 percent and NASDAQ up 45 percent. I think most of us would agree 2020 was a good year for the stock market.
In understanding the differences between the stock market and the economy, one of the major differences deals with small businesses. Your typical small business is not reflected in the stock market since their stock is not listed on any exchange. Anywhere between 40 to 50 percent of the United States GDP is small business. Therefore, small businesses have a substantial impact on GDP, but they have no impact in the stock market. That is why the stock market and the economy are not the same.
I should also add that nearly 50 percent of Americans work in small businesses. Most times the stock market and the economy move in the same direction; however, that is not always the case and therefore, you can’t use the GDP numbers as a guideline for how you should invest your money.
During the webinar, I also discussed the importance of rebalancing portfolios. Unfortunately, the great majority of investors don’t rebalance regularly. Rebalancing your portfolio brings it back to its original asset allocation after market fluctuations.
For example, if when you establish your portfolio you wanted to have 25 percent of your portfolio in large cap U.S., and today your portfolio contains 35 percent, when you rebalance, you reduce your exposure to large cap U.S. by 10 percent and invest that 10 percent in something that’s underweight. You rebalance your portfolio because you recognize that one of the main ingredients to investor success is having the right allocation.
However, you just can’t set up a portfolio once with the right allocations and let it go. You rebalance occasionally to bring the portfolio back in line with your intended allocation. By having the discipline to rebalance your portfolio at least once or twice a year, you substantially increase the likelihood of success.
When rebalancing, you are typically selling winners and then turning around and buying investments that have not done as well. Rebalancing is actually the practice of selling high and buying low. As far as I’m concerned, when you do this, you’re on track for success in the stock market.
In managing your portfolio and deciding how to invest your money, don’t focus on the economy. Rather, your main focus should be on your individual goals and objectives, and your risk tolerance levels. By using the aforementioned as a guide as opposed to focusing on the economy and its direction, I believe you will be much more successful.
Rick Bloom is a fee-only financial advisor. His website is www.bloomadvisors.com. If you would like him to respond to your questions, email firstname.lastname@example.org.