The majority of investors believe that it's important to follow the market every day; however, learning the basic financial concepts of investing is a better investment of your time than following every action of the market. Finance is littered with jargon, and some terms are more important for you to understand than others.
Here is an overview of what you should understand about the daily market so you can interpret its changes and take the appropriate actions as an investor.
Common Financial Phrases Used to Describe the Market
Let’s start with some financial headlines and lead-ins and the terminology they contain.
“The market was up 10 points today on better-than-expected 3rd quarter earnings at [x company].”
The majority of the time “the market” refers to the stock market and, more specifically, the S&P 500, which represents the 500 largest U.S. companies and has become the standard measuring stick for judging the success of “the market." Historically, the Dow Jones Industrial Average was the standard gauge, however the fact that it is only comprised of 30 companies makes it less representative of the broad market. “The market” can also mean such things as the bond market, treasury market or housing market.
"Index Up 10 Points"
When the term "up 10 points" is used in connection with the market, it means the index went up 10 points from where it began that day. For example, a rise of 10 points on the S&P 500 that started the day at 2570 is a .39% gain. So taking the average of all the price movements of the underlying stocks of the index that day comes out to a gain of .39%.
"[X Company] Beats Earnings"
Essentially, earnings are the amount of after-tax profit a company earns during a given time period, usually over a quarter (three months) or a year. Market analysts make quarterly and yearly estimates of each company's earnings. If a company manages to exceed these estimates, this company is said to have "beaten earnings." When this happens, it is usually a signal to the financial world that the company is performing well and is likely to experience continued success.
The Impact of the Daily Market on Long-Term Investors
As a long-term investor, daily market activity has very little impact on how well your overall investment strategy performs. The market will fluctuate because that’s what it does. On some days, investors can observe extreme levels of volatility (a measure of price fluctuation).
Pundits and analysts are always trying to explain away market movements, but the reality is many factors—some external to the markets themselves—drive daily fluctuations in the market. Politics, international conflict, natural disasters and the supply and availability of certain commodities (like oil) can all cause the market to swing.
So what action should you take as a long-term investor after a bumpy day in the market? None. Your investment decisions should be based on your individual goals, time horizon, and risk tolerance and should not shift based on a bad day in the market. (For more from this author, see: Diversification: The Right Way to Manage Risk.)
Therefore, as a long-term investor, you can view the market more as an interesting news headline that reports on the daily emotional pulse of the economy rather than a predictor of your future financial success or demise. No single day of trading in the stock market should have much bearing on your personal finances if you’re saving for retirement in a well-diversified investment portfolio.
Day-to-Day Market Movements and Earnings: Irrelevant for the Long-Term Investor
No one knows what the future holds. If we did, we would all be able to spot the next dotcom boom and the next key players in the stock market, like Amazon. Day-to-day market movements are irrelevant for the long-term investor; and earnings, while important, are more of a game that traders and analysts play for short-term profit (trading around expectations, if you beat earnings your stock goes up, if you don’t, it goes down) than long-term financial independence.
(For more from this author, see: The 3 Unbreakable Rules for Success.)