When people ask, “How’s the market doing?” the response is typically based on how the Dow Jones Industrial Average is doing (Dow for short). The Dow has been around since the late 1800s, so it has a long history of measuring how the US stock market has performed.
Despite its popularity and longevity, the Dow has some quirks that make it not necessarily the best way to measure how the overall US stock market is performing.
Recently, the powers that be decided to drop an iconic company that had been in the index off and on for more than 100 years. General Electric was one of the original companies in the index back in 1896 and has been continuously in the index since 1907. But not anymore.
One of my core philosophies is that a successful investment strategy depends on viewing our economy through a very wide lens. And just as the Dow is bigger than GE, our economy is much bigger than just the Dow, or the S&P 500, or whatever other number the media is talking about on cable news.
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Key Questions on the Dow Removing GE
1. What is the Dow Jones Industrial Average anyway?
24,000 … 25,000 … 26,000 … We see these numbers bouncing all over cable news and social media every day. But what do they really mean?
The Dow is an index composed of just 30 select stocks that are trading on the New York Stock Exchange and the NASDAQ Exchange. The average is calculated as the sum of each stock price, which is then adjusted by a factor which changes whenever one of the component stocks has a stock split or stock dividend. This factor helps to generate a consistent value for the index. This is known as a price-weighted index.
A board at Dow Jones chooses 30 stocks that it believes are representative of the US economy. In 1896, the Dow was based on 12 stocks. Since then, the stocks measured have changed 52 times. Until last month, GE was the only company of the original 12 that was still on the index. The last major shakeup occurred in 2015 when Apple replaced AT&T.
2. So why the change?
Despite its diverse business interests – including owning NBC – GE’s stock market capitalization has declined by about $150 billion in the last year. The board at Dow Jones decided that Walgreens is a better representative of the US economy.
3. Wait … Did you say the Dow is a weighted average of only 30 stocks?
4. That’s not very many.
In fact, here’s a quick list of companies that aren’t in the Dow: Facebook, Google, Amazon, Berkshire Hathaway.
Why not? Because their stock prices are so high that they’d throw off the weighted index. Apple only made the cut after it “split” its stock in 2014 7 for 1, meaning they divided their stock price by 7 and gave existing shareholders an equivalent amount of new shares so they were made “whole” after the split.
The S&P 500 is, arguably, a better indicator of how the economy is doing, because it weighs the 500 largest companies by market cap. But even analyzing 500 companies is still just one factor in a large, complex economic picture that also includes stats like the unemployment rate, housing prices, the consumer price index, and construction starts.
5. So why do we care so much about the Dow and S&P 500?
In part, because we always have. Despite their limitations, these numbers do offer a snapshot of our economy’s health, and their fluctuations can influence market trends and investor behavior. Plus, they are big, easily-digestible, and easily-reportable numbers that can simplify market trends for large audiences and generate clickable headlines.
But, again, at Keen Wealth, we prefer the panoramic view to a snapshot. The Dow and the S&P 500 just don’t tell the whole story, especially for folks who are unfamiliar with how these averages are weighted and calculated. Price swings in one or two stocks can drastically change these weighted averages without having any meaningful effect on your investments.
6. What does dropping GE from the Dow say about the state of our economy?
Probably the biggest takeaway is that the modern global economy continues to develop at a faster and faster pace. The companies that are able to adapt are the ones that will continue to flourish. The ones that don’t are destined for the same kinds of hardships GE is experiencing right now. Just look at another popular economic list, the Fortune 500. Of the 500 companies that made the original list in 1955, only 12% were still around at the end of 2016.
However, there is one pretty reliable constant in this shifting business landscape: when you look at the markets through a panoramic lens, the numbers continue to trend upwards. As we forecasted at the end of last year, 2018 has had its share of economic ups and downs. But the underlying fundamentals of the economy are strong, and a diversified portfolio that isn’t overly reliant on one or two companies is still a powerful path to building wealth in the long run.
That’s why it’s so important not to overreact to the decision to drop GE from the Dow, or any other single economic development. It’s also why we encourage married couples to take an active role in financial planning together, especially as you near retirement. Both spouses should understand how the family’s finances work and how market volatility will – and won’t – affect that plan.
If the GE news or any other market trends have you or your spouse unsettled about your plan, call us at Keen Wealth and make an appointment to talk to one of our fiduciary advisors.
Bill Keen on the Dow …
“Just as the Dow is bigger than GE, our economy is much bigger than just the Dow, or the S&P 500.”
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Bill Keen is a CHARTERED RETIREMENT PLANNING COUNSELOR℠ and independent financial advisor with more than 25 years of industry experience. As the founder and CEO of Keen Wealth Advisors, a registered investment advisory firm, he specializes in providing personalized retirement planning designed to help people thrive before and during their retirement years. With a passion for educating others, Bill regularly blogs about retirement planning, hosts the podcast Keen on Retirement, and has contributed to U.S. News and World Report, Reuters, Wall Street Journal’s Market Watch, Yahoo Finance, and other publications. Based in Overland Park, Kansas, Bill and his team work with clients throughout the greater Kansas City area and across the nation. To learn more, connect with him on LinkedIn or visit www.keenwealthadvisors.com.
Keen Wealth Advisors is a Registered Investment Adviser. Nothing within this commentary constitutes investment advice, performance data or any recommendation that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. Keen Wealth Advisors manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed here. Investments in securities involve the risk of loss. Past performance is no guarantee of future results.