How Does Wall Street Affect the Economy—And Your Wallet?

Much of the economic information on the news is tuned into Wall Street—but for many, the ups and downs of the stock market might seem distant and abstract. How does Wall Street affect the economy on a tangible level? What impacts can it have on your personal financial situation?

The stock market is one of the key indicators of national and global economic performance. As such, fluctuations can impact many aspects of your life, including employment, major purchases and interest rates.

To get at the "why" behind these impacts, it's important to understand what drives fluctuations in the stock market and the ripple effects they can have across the financial world.

The ins and outs of market fluctuations

The stock market is where investors buy and sell company stocks. Market changes occur because of shifts in investor demand and stock supply. One major factor that can impact a stock's supply and demand is the company's health.

For example, if a company reports higher profits, demand for its stock typically increases, raising the stock price. Similarly, if a company needs to temporarily halt services—like airlines and hotels did during the pandemic—this can result in decreased profits, often reflected by a decline in the stock price. There are many contributing factors to the health of a company—including profit, expenses, inventory, debt and revenue streams—and changes in any of these areas can impact the price of its stock.

There are also external events that may contribute to market volatility. Examples include Federal Reserve rate changes, natural disasters and geopolitical events, such as trade wars. These events may cause the stock market to fluctuate as investors react to the news based on their emotions, even though these changes may not necessarily impact the overall health of publicly traded companies.

The impacts on your everyday life

So, how does Wall Street affect the economy? Even if you don't own any stock yourself, Wall Street can impact various areas of the economy that you might feel very strongly about in your day-to-day life. Here are a few notable examples.

Employment

A company's falling stock price may impact employment at that organization. If a company loses significant profit and its stock price drastically drops, a CEO might need to make difficult decisions, such as closing locations or laying off employees in order to stabilize the company's health and stock price.

Retirement savings

Stock market fluctuations may also impact your retirement savings. For example, many pensions are at least partially invested in the stock market, as are most 401(k)s and other individual retirement accounts (IRAs). If the market sharply contracts, you might see the amount of money you have in an IRA decrease, often temporarily. Furthermore, some employers may stop providing a company match into an employer-sponsored plan or even eliminate the plan during tough economic times, which can interrupt your plans to save for retirement.

Interest rates

Often, a stock market crash precedes a drop in consumer and business spending. To encourage spending and stimulate the economy, the Federal Reserve may choose to lower interest rates. Many other rates follow suit, including lowered credit card APRs, mortgage rates and car loan rates. This can be a boon to consumers because lower interest rates make it less expensive to borrow money. But lower interest rates also have a downside: the rates on your savings accounts and certificates of deposit typically also decrease, giving you less return on your money.

Putting it all into perspective

You probably don't need to watch for stock market changes hour by hour or day to day. But because Wall Street can affect your employment prospects, retirement savings and major purchasing decisions, keeping an eye on its long-term performance can be helpful. A great place to start is to follow the big-name stock market indices—S&P 500, Dow Jones Industrial Average and Nasdaq Composite—looking for any sudden shifts or week-to-week trends.

It's also wise to keep in mind that the stock market doesn't reflect the whole economy. Most US workers aren't employed by publicly traded companies, and a lot more goes into total gross domestic product, or GDP, than stock performance. Many businesses may be struggling or thriving at any given time, and the market may not reflect their status. For example, following the economic fallout of the COVID-19 pandemic, stock market performance has bounced back much more quickly than unemployment numbers.

So, although the stock market is important to follow, it's not the only indicator of a healthy economy. Other economic indicators to follow include GDP, job numbers and the Consumer Price Index, which the US Bureau of Labor Statistics uses to measure changes in the average cost of basic goods over time.

If you're thinking about investing in the stock market, remember that it's important to manage and diversify your portfolio for the long term. Look at the full picture of the economy, and focus on your goals for the future rather than the short-term fluctuations of Wall Street.