The Dow Broke Through 11,000 this Week! Who cares?

Every time an index, especially the Dow, approaches and goes beyond round numbers (e.g. 11,000), you'll hear about it on the news.  Look to the New York Times, the Wall Street Journal, and the Chicago Sun-Times for examples.  Some claim it provides a psychological boost for the market.

Concentrating on a particular number as a milestone is silly.  11,000 is better than 10,990 the same amount that 10,980 is better than 10,970.  You don't see articles about 10,980.  11,000 is only impressive, because we use a base 10 number system.  If we used binary, reporters would have been going nuts when we crossed 10,000,000,000,000 back in July 2009 (that's 8,192 for those of you who aren't engineers).

It is useful to stop and reflect now and then, and perhaps using such numbers is as good a marker as any.  The markers shouldn't be given any special meaning, though.  The importance of particular numbers is simply a human construct placed upon an otherwise insignificant label.  The value of dollars and gold has a similar issue, but that is a conversation for another day.

A Tax Refund Isn't a Good Thing

Tax Day is coming up this week.  If you haven't already filed, then get it done.

Many people get excited about the prospect of a refund on their taxes.  If you are a competent saver, though, you shouldn't be.  Getting a refund means that you overpaid taxes during the past year.  The IRS has been happily taking your money, earning investment income on it, and will give it back to you after you file.

Instead, you should arrange your W-4 with your employer to withhold less of your salary for taxes.  The goal is to owe a little to the IRS when you file your taxes.  That way, you keep your money as long as possible, and you earn interest on it instead of them.  Don't lower your withholdings too much, though, or the IRS will fine you.

This method also means you won't be waiting around wondering if your tax paperwork got to the IRS successfully.  You'll know when they cash your check.

Externalities

Externality is an economic term that everyone should know.  The Glossary of Research Economics defines it as "An effect of a purchase or use decision by one set of parties on others who did not have a choice and whose interests were not taken into account."  That may be a bit hard to digest, so I'll give some examples.  Externalities can be both positive and negative, meaning the effects on the party who was not involved in the choice can be good or bad.

Imagine a homeowner spends $1000 and twenty hours of his time planting a garden in front of his house.  He is not planning to sell his house any time soon; he just loves gardens.  If he did sell, though, this improvement could increase his asking price and/or sell his house faster, because when potential buyers first visit the house they will likely have a more positive outlook when they see the nice garden.  Now imagine his next door neighbor is trying to sell her house a month after he plants the garden.  Potential buyers of her house will see his garden and could have similar feelings.  She would benefit from his economic decisions, and it is highly unlikely that she will write him a check for a few hundred dollars when her house sells.  This is a positive externality: his decision to plant a garden (a decision she was not involved in) benefits her and she does not reimburse him for the benefit.

For a negative externality, imagine the same two neighbors.  Now, though, instead of planting a garden, he has a broken down Pontiac sitting on his front lawn that he works on perpetually.

Negative externalities get much more attention from economists and policymakers than positive externalities, understandably so.  They are especially important in environmental policy.  I think about them during social welfare debates, too.

Saving and Debt to Income Ratios

My parents mailed me this Wall Street Journal article back in 2005: Ugly Math: Soaring Housing Costs Are Jeopardizing Retirement Savings.  I found it while cleaning out some old file folders.

It talks about how rising home prices of that time were keeping people from saving as they should while also ratcheting up their debt levels.  We're dealing with other economic problems these days, but the table in the article is still a great wake up call.

So, let's say you are 30 years old and making $50,000 a year.  You should have at least $5000 in savings, preferably in a IRA or other retirement tax shelter.  Meanwhile, your debt (including credit cards, student loans, car, and mortgage) should be no higher than $85,000.




Don't get too depressed; most of your friends aren't there either.  Just think about this when you get your next bonus or other windfall.  Perhaps you should split it between savings and student loans rather than buy a new TV.

The Market is More than Three Numbers

When you hear and read financial news, you likely get reports on the Dow, the S&P 500, and the NASDAQ.  These are indexes that track particular segments of the stock market.

They don't track the whole market, though.  More than 9,000 stocks are traded in the United States stock market.  The Dow Jones Industrial Average is limited to thirty very large companies.  The Standard & Poor's 500 tracks five hundred large cap companies.  The NASDAQ Composite tracks the stocks that trade on the NASDAQ stock exchange, but that only covers about a third of all the stocks and they are often more technology focused.

For a more complete picture, you should also pay attention to other indexes.  Check out the S&P 400 (a mid cap index) and the S&P 600 (a small cap index), for example.  The Russell Investment Group also has a set of indexes, as do other organizations.  Here is a good list of United States indexes.  You'll see on that Wikipedia page that many countries have their own indexes.