The Wealth Effect

DEFINITION of 'The Wealth Effect'

The premise that when the value of stock portfolios rises due to escalating stock prices, investors feel more comfortable and secure about their wealth, causing them to spend more. For example, economists in 1968 were baffled when a 10% tax hike failed to slow down consumer spending. Later this continued spending was attributed to the wealth effect. While disposable income fell as a result of increased taxes, wealth was rising sharply as the stock market moved up. Undaunted, consumers continued their spending spree.

BREAKING DOWN 'The Wealth Effect'

The wealth effect helps to power economies during bull markets. Big gains in people's portfolios can make them feel more secure about their wealth and their spending. However, the relationship between spending and stock market performance is a double-edged sword as poor stock prices in bear markets hurt economic confidence.

RELATED TERMS
  1. Draghi Effect

    The calming effect of European Central Bank President, Mario ...
  2. George Bailey Effect

    A feeling of increased gratefulness for what one has upon considering ...
  3. Hierarchy-Of-Effects Theory

    A hierarchical representation of how advertising influences a ...
  4. Lipstick Effect

    A theory that states that during periods of recession or economic ...
  5. Bandwagon Effect

    A psychological phenomenon whereby people do something primarily ...
  6. Clientele Effect

    The theory that a company's stock price will move according to ...
Related Articles
  1. Options & Futures

    Terrorism's Effects on Wall Street

    Terrorist activity tends to have a negative impact on the markets, but just how much? Find out how to take cover.
  2. Insurance

    The Causes And Effects Of Credit Shocks

    These shocks cycle through history. Find out what you need to know to avoid the alarm bells.
  3. Investing Basics

    Portfolio Growth Strategies

    There are many ways to grow a portfolio, and the best approach for a given investor will depend upon various factors.
  4. Investing Basics

    Income, Value and Growth Stocks

    Investors who buy stocks generally seek one of three criteria: undervalued holdings, growth potential or steady income. The characteristics of stocks in each of these categories differs accordingly.
  5. Active Trading Fundamentals

    Capitalizing On Seasonal Effects

    We show you how to take advantage of periodic trends in the equity markets.
  6. Economics

    5 Economic Effects Of Country Liberalization

    Liberalization provides new opportunities for diversification and profit.
  7. Fundamental Analysis

    How To Construct A High-Risk Portfolio

    Over time, intelligent and disciplined risk-seeking behavior can produce substantially above-average returns.
  8. Options & Futures

    January Effect Revives Battered Stocks

    Make sure you buy in low to ride this phenomenon for all it's worth.
  9. Fundamental Analysis

    Lipstick And The Stock Market: Connection?

    We test the theory that lipstick sales thrive during an economic downturn.
  10. Retirement

    Economic Indicators To Know

    The economy has a large impact on the market. Learn how to interpret the most important reports.
RELATED FAQS
  1. What effect do stock buybacks have on the economy?

    Stock buybacks have a mildly positive effect on the economy as they lead to rising stock prices. Research has shown that ... Read Full Answer >>
  2. What's the difference between microeconomics and macroeconomics?

    Microeconomics is generally the study of individuals and business decisions, macroeconomics looks at higher up country and ... Read Full Answer >>
  3. Is Israel a developed country?

    Israel is considered a developed country, although it has substantial poverty and large income gaps. The International Monetary ... Read Full Answer >>
  4. How do mutual funds split?

    Mutual funds split in the same way that individual stocks split, but less often. Like a stock split, mutual fund splits do ... Read Full Answer >>
  5. What economic indicators are important to consider when investing in the retail sector?

    The unemployment rate and Consumer Confidence Index (CCI) rank as two of the most important economic indicators to consider ... Read Full Answer >>
  6. What types of expenses are factored into autonomous consumption?

    Autonomous consumption is the level of consumption necessary to support everyday life in a zero-income scenario. Put another ... Read Full Answer >>
Hot Definitions
  1. Presidential Election Cycle (Theory)

    A theory developed by Yale Hirsch that states that U.S. stock markets are weakest in the year following the election of a ...
  2. Super Bowl Indicator

    An indicator based on the belief that a Super Bowl win for a team from the old AFL (AFC division) foretells a decline in ...
  3. Flight To Quality

    The action of investors moving their capital away from riskier investments to the safest possible investment vehicles. This ...
  4. Discouraged Worker

    A person who is eligible for employment and is able to work, but is currently unemployed and has not attempted to find employment ...
  5. Ponzimonium

    After Bernard Madoff's $65 billion Ponzi scheme was revealed, many new (smaller-scale) Ponzi schemers became exposed. Ponzimonium ...
  6. Quarterly Earnings Report

    A quarterly filing made by public companies to report their performance. Included in earnings reports are items such as net ...
Trading Center