In the 21st century access to information is more readily available than ever before. When it comes to the “markets” the Dow and the S&P 500 seem to be the most seen, talked about, and followed indexes in the United States. But very few people know what they are looking at or stop to ask if what they are looking at is relevant to their situation.
So, what is the Dow and what is the S&P 500 and are they relevant to my portfolio? Over the course of the next three posts I will give a brief explanation of the two indexes and then finish up with the, “are they relevant to me” question.
Each of these indicators, the Dow and the S&P 500, is an index*. The purpose of the index is to give a general idea of the movement of “the market” over a given period. They are also often used either on their own or paired with other indexes to create a benchmark for an investor to measure their portfolio against.
The Dow Jones Industrial Average is arguably the most popular and well known of the indexes in the market place. It is made up of 30 large, well-known US stocks that are traded on the New York Stock Exchange. The Dow was created in 1896 by Charles Dow and was originally 12 US corporations. It was expanded to 20 corporations in 1916 and then moved to the current count of 30 in 1928. It is owned and maintained by the Wall Street Journal. The 30 stocks that compose the Dow must satisfy a list of criteria to be added and included in the index. If a stock that is in the Dow does not meet one of the criteria, over time it may be removed and replaced by another stock.
Though the Dow is popular among investors and the media, it has two weaknesses when it comes to using it as a benchmark for measuring your portfolio. One, the way its return is calculated. The Dow uses a price-weighted average for calculating its return which gives more importance to a stock’s price rather than its actual size in the portfolio. Two, the Dow only represents 30 stocks in the US market which is a very small portion 4300 stocks that are traded on the US markets.
With the price weighted calculation and a small number of stocks, the Dow can vary widely day to day if one of its stocks has a volatile day. This is why you may notice the variance in the Dow’s daily results compared the results of the other indexes or even your own portfolio.
In the next post I will discuss the S&P 500, looking at its pros and cons in the return calculation and the makeup of the index. We will finish up the following week with the question of relevance as a portfolio benchmark.
*An index is not managed and cannot be invested into directly.
It is all too easy to lose your cool when the markets are rising or falling. When markets are rising we wonder if it can last forever, often times believing that it will go bad soon. When it is falling, it feels like things will never turn around and we worry about how much more it could drop. Markets are volatile, and volatility on the up or down side can be scary. If you can’t stay calm and make rational investment decisions in the face of this volatility you will almost certainly see the value of your investments suffer. Legendary investor Shelby Davis once said, “you make most of your money in a bear (down) market, you just don’t realize it at the time”. Because volatile markets are ripe with opportunity to either lose or make money it is important to have a strategy in place ahead of time, so you can make rational decisions while others around you are panicking.
Below are five fundamental blocks that you can build your investment philosophy on to help prepare you for the next round of volatility in the markets.
- Plan to live a long time – According to the Center for Disease Control a 65 year-old woman has a 20.3 year life expectancy, and a 65 year-old man has a 17.7 year life expectancy. This information might cause you some confusion if you’ve read that the average life expectancy in the U.S. is currently 81.1 for women and 76.1 for men. But these life expectancies are from birth — they don’t apply to someone who’s already reached age 65. If you are healthy and 65, don’t talk yourself into moving all your money into cash or CD’s. If you are counting on income from these investments now and into your future, you will want to take some level of risk to make sure you don’t run out of money. Inflation is a big threat to your money and it is not easy to see it coming. Plan for it.
- Diversification works – The old saying goes, “don’t put all of your eggs in one basket”. This is fine for most things but when investing, the saying should probably be more like, “don’t just own eggs”. No one knows what the future for markets will hold. Even when one sector does well others can suffer, so own multiple classes of investments and multiple investments. This will give you a more consistent return and help to reduce the volatility of the general market. Although it is tempting to buy into whatever did well last year, don’t do it. This is the equivalent of driving down the road looking through your rear-view mirror. Do this and you might find yourself in the ditch at the side of the road.
- Don’t follow the crowd – The crowd is often terrible at investing. Don’t get caught up in the hype of a stock or particular sector. The average investor tends to buy high, sell low, and make decisions about their investing based on their gut reaction to a single piece of news. We all know that is an easy way to lose money in the market, but we often forget that making money in the markets can be just as simple. Warren Buffet has said that he only invests in companies that he is comfortable holding for 30 years. Buy investments that you believe will still be successful over the long term because of their fundamentals and don’t make decisions based on fear, greed, or hype.
- Block out the noise – 24-hour news and the internet are the wrong places to spend your time if you are trying to make good investment decisions. Don’t get me wrong, they are a wealth of knowledge and can add lots of value to your decision-making process but for most people, they are just NOISE. By the way, that is what they are designed to be, they are designed to catch your attention, keep your attention, and move you to action. That is how their paying customers, advertisers, make money. When things look bad and you feel yourself getting nervous, turn it off!
- It’s about time IN the market, not TIMING the market – We all want to make money in the market without losing any money in the market. That is a good strategy, for a fortune teller, but you’re not one. If you were you wouldn’t be reading my blog on investing strategies. The cost of missing days in the market can be enormous and almost impossible to make back up. If you missed the 25 best trading days (out of 11620) from 1970 to 2015 your return dropped from 1,910% to 371%. Ouch… Market investors should not be focused on day to day returns but instead on their long-term investment goals. Stay invested in bad times or you might just miss out on the good times.
As 2017 winds down and 2018 is coming into sight we are receiving more and more questions about our outlook for the new year. While we rarely make predictions about where the markets will be at any point in time, we do want to share a few thoughts on our general outlook for the economy going forward.
While the US has been in an economic recovery for more than 8 straight years, the recovery has yet to reach its full potential. In 2017 we started to see the economy accelerate in growth from the 2.5% GDP number that we have been seeing into the 3% range.
We believe that we will continue to see this trend in 2018 largely lead by improvements in 4 key economic fundamental indicators. Below is a list of these economic pillars that we keep a watchful eye on when making decisions on the direction of our client’s investments. When looking at these 4 pillars we believe that we have a lot to be thankful for and feel that we will continue to see economic growth and prosperity in the new year as these pillars continue to strengthen.
- Monetary Policy is not tight – The Federal Reserve has been in the news recently for their final move of 2017 by raise short term interest rates to a range of 1.25% – 1.5%. Many fear that the Fed is tightening the money supply too fast, but we are not in this camp. We believe that a short-term interest rate of 1.5% is still well below a healthy short-term rate and that the Fed still has plenty of room to raise rates in 2018. A normalization of rates will continue to send signals to the market that the Fed believes the economy is on a positive track. Positive
- Trade Policy is not changing, much – Protectionist policies have been discussed for much of 2016 and 2017. After his inauguration, the President issued an executive order that removed the US from the Trans-Pacific Partnership that was signed in February of 2016. Because the agreement was so new we don’t believe that it had much effect on US trade and don’t believe that the withdraw will have much negative impact on future trade. The US is still part of NAFTA and with other policy initiatives ahead of it, it appears to be secure for now. The World Trade Organization has estimated growth in global trade for 2017 will increase from 2016 by 4.2%. This is double the growth we saw from 2015 to 2016. Positive
- Tax Policy is putting money back in the private sector– On December 22 the President signed into law the largest tax reform bill in decades. While there will always be discussion about rich and poor and who is or is not paying their “fair share”, one thing that we do believe is that dollars are more effectively and efficiently allocated by individuals than by any government. We believe that while this tax policy is not perfect it is a step in the direction of putting money back into the hands of the people and that it will in turn spur economic growth. One concern is that it may increase the deficit over the next 10 years. Positive
- Regulation growth is slowing – Regulation growth in 2017 has slowed considerably. Ending in 2016 we were on pace to add 800,000 new pages of regulation in this decade. That would be an increase in new regulation created of over 60% since the 1980’s. While regulation is often a positive on the surface we do not always consider the cost of enacting these policies, such as lost economic growth. When government creates regulations that complicate a process or make rules unclear for individuals and business, activity slows. This has an economic cost that is unseen. With the slowdown of new regulation in 2017 and we would expect in 2018, we are already starting to see capital spending by business pick up. Positive
With all of this in mind we feel like we are on strong footing going into 2018. The 4th quarter GDP number has not officially been announced but when it is we fully expect that is will be at 3%+. Once it is in the books this will be the first time since 2004 that we have had three consecutive quarters of 3%+ GDP growth in a row. We expect that with the most recent pick up in the movement in money that will see this trend continue into 2018.
Cheers to a healthy and prosperous 2018!
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Let’s be honest, personal finance can be confusing. There are taxes, investments, estate planning, and insurance concerns to think about, just to name a few. Within each of these topics are questions to ask: IRA or ROTH IRA; am I taking the right tax deductions; should I pay off my mortgage before I retire; what is a trust and do I need one; have I saved enough; and the ever dreaded, am I going to run out of money.
On top of all of that there is the economy, the Federal Reserve, geopolitical issues, debt ceilings, and government shut-downs that flash in front of you all day long through all sorts of outlets. There is no shortage of information available today, but the challenge is filtering down all of this “information” to what matters to you.
The intent of this blog is to introduce you to topics you may not be familiar with and expand your knowledge on topics you already know and would like to learn more about. I welcome your feedback and questions, because my hope is this blog will spark more conversations about what affects and interests you most.
This blog will take the place of the emails that you occasionally receive from me so that each post is archived in one place for you to revisit and share with friends and family.