What goes up ...
Kendall W. King, president of Castleview Wealth Advisors, explains why the Dow isn’t the go-to index for financial planners.
Q: What is the Dow Jones industrial average?
A:
The Dow Jones is the most recognized stock index in the U.S. but most people don’t know exactly what it measures or tracks. Charles Dow created the Dow in 1896, initially having only 12 industrial stocks. Currently, it’s the priceweighted average of 30 large U.S. publicly traded companies’ stocks that were chosen as being representative of the broad market and American industry. Price-weighted simply means that the higher-priced stocks in the Dow will have greater impact over the performance of the Dow than the lower-priced stocks. For example, Apple trades well over $120 compared with General Electric trading at around $30. So, Apple’s price movement will have around four times the effect of a similar percentage move in General Electric.
Q: Is the Dow Jones a good benchmark for investors? A:
Although the Dow is the primary market measure that is tracked by the news outlets, it has many shortcomings as far as tracking the performance of stocks. Keep in mind that there are well over 5,000 companies that trade on the New York Stock Exchange and Nasdaq, so that means you’re only seeing how 30 of these companies are performing when you look at the Dow. The S&P 500 index is a much better indicator of how stocks are doing since it tracks the largest 500 companies in the U.S. To put this difference in perspective, the Dow covers fewer than 25 percent of the U.S. stock market compared with the S&P 500 covering around 70 percent. Additionally, if you have non-U.S. stock exposure, the MSCI EAFE, representing the Europe, Australia and the Far East countries, helps you track stock performance for companies in these international markets.
Q: With the Dow Jones reaching 20,000, does this signal a good or bad time to invest?
A:
Similar to the Dow reaching 15,000 for the first time in 2013 or the S&P 500 reaching 2,000 in 2014, 20,000 Dow is obviously a psychological number that grabs investor’s attention, but it doesn’t signal useful clues for future investing. History tells us that when a market index reaches an all-time high, it hasn’t proven to be a reliable indicator for investors on whether it’s time to cash out of their portfolios, stay invested, or invest more. From 1926 through 2016, the S&P 500 has experienced positive returns about 80 percent of the time in the 12 months following a new index high like we have seen recently. To compare to all periods in this same period of 1926 through 2016, the S&P 500 has experienced positive returns about 75 percent of the time in each 12-month period regardless of where the index closed previously. Instead of looking at index milestones to make investment decisions, investors are much better off designing a long-term investment plan that aligns their portfolio’s asset allocation with their future goals, timeline and ability to stomach short-term market volatility.