Thursday, June 11, 2020: the market’s down 1,800 points
Friday, June 12, 2020: the market’s up 500 points
Tuesday, June 16, 2020: the market opens up nearly 800 points, slashing losses from last week
Did you hear those headlines in the last few days?
The market’s been volatile is an understatement, but have you paused to ask yourself: “What ‘market’ are they talking about?”
It’s the stock market they’re referring to in the news, but is the benchmark they are quoting an indicator of what you can expect in your portfolios?
If you listen to or watch the news, you’ve probably heard reporters referring to the Dow Jones when discussing the stock market. People often feel optimistic when they hear the Dow Jones is up (like today), but uneasy when the opposite is true because they assume that the performance of the Dow Jones is a reflection of the condition of the entire U.S. economy and stock market.
But the Dow Jones doesn’t tell the whole story.
What is the Dow Jones?
The Dow Jones Industrial Average (DJIA), or simply Dow Jones or the Dow, is an index that tracks and measures the performance of just 30 large, publicly owned blue-chip companies traded on the New York Stock Exchange (NYSE) and the NASDAQ. Blue-chip companies are those which have a national reputation as leaders in their industry and have been in business for decades – and typically pay dividends. Think companies like Coca Cola, Disney, Johnson & Johnson, Home Depot, and McDonald’s.
What are the flaws of referencing the Dow Jones?
1) Because it tracks just 30 companies, one hurting company can impact the direction of the Dow Jones for the day. But just because Disney stock is down, for example, doesn’t mean the entire U.S. economy or stock market is.
2) The weight of each of the 30 companies is determined by the price of their stock rather than market capitalization. Market capitalization refers to the total value of a company’s outstanding shares, which is more accurate at assessing a company’s value compared to just looking at the ever-fluctuating stock prices. Companies with higher share prices influence the index more than those with lower prices, regardless of the company size, value, or performance.
3) 30 companies is not reflective of the global market. There are other types of markets that exist out there besides the stock market that your portfolio is more than likely exposed to such as the fixed income (i.e. bonds) market, commodities market, real estate market, etc. When you are listening to the news, they don’t really tell you how well these other markets are performing and how they globally influence the economy.
Why does the media always quote the Dow Jones?
Probably a combination of tradition and the fact that the market capitalization of the companies listed in the Dow Jones make up a larger percentage of the U.S. stock market. The Dow is one of the oldest and most widely recognized indices of the stock market and has included some of the largest U.S. companies across a wide span of industries since its inception in 1896.
There are other indices or benchmarks, such as the S&P 500 or Russell 1000 index, that are generally believed to give a more solid representation of the U.S. stock market. But you can’t rely on these indices solely either since they only represent the U.S., not the global market.
Should you compare your portfolio’s performance to the Dow?
Unless your entire portfolio of accounts – including your investment and retirement accounts together – consist of only the Dow Jones index or its 30 stocks, it’s not an apples-to-apples comparison. If your portfolio is diversified and consists a mix of bonds, commodities, real estate, other stocks not listed on the Dow, or has an array of index funds, then its performance will be very different than what’s quoted in the Dow.
You would need to compare your portfolio to an index that has a similar basket of investments as yours to get a better grasp on how well it is performing.
For example, if your portfolio is 60% in equities and 40% in fixed income, the total return may be 11% whereas the Dow is up 17% quarter-to-date. You may be thinking: “okay, the Dow did much better in the last 3 months.”
But did you consider how it’s performed year-to-date (YTD), reflecting all that has happened this year so far?
Year-to-date, the Dow is down -9.2% versus a diversified 60/40 portfolio* that’s down only 1.6%.*
You may be tempted to chasing the hottest stock or index all day, but diversity allows you to spread out risk and not be highly concentrated and reliant on just one index or stock.
Sounds boring, but our aim is to mitigate risk as much as possible, not just chase returns and outperformance.
THE BOTTOM LINE:
Too much of one thing is never good and you should never rely on any single source for your information. In this case, don’t expect the performance of the Dow Jones alone to paint you a perfect picture of the U.S. economy and stock market.
In short, the Dow Jones is just a small reflection of the entire global stock market; so, don’t rely on it as a primary benchmark to compare your own portfolio’s performance.