With all the major market indices hitting new highs recently, some media reports are giddy about the Dow Jones Industrial Average (The Dow) hitting 20,000 points for the first time.
So what is all the fuss about?
A Quick History of The Dow
The Dow has rich history and was among the first measures of the “whole” market when introduced in 1885 as the Dow Jones Average. At that time the Dow included 12 companies including GE which is the only stock still included today. Early on, these companies represented heavy industry but that distinction is long gone. The 30 companies that make up the index today are a broad representation of the market, selected by S&P Dow Jones Indices, the index owner.
How The Dow is Calculated
To call it an average is a bit misleading. The index is calculated by adding up all the prices of the included stocks. This number is then divided by a number that reflects all the stock splits, spin-offs and other restructures of the included stocks. The result is a price-weighted index adjusted for changes in the underlying stocks over time but clearly not an average.
The highest priced stock in the index, which is now Goldman Sachs at about $247 per share, has a much greater impact on the value than the lowest priced stock, now GE at about $30 per share. So any change in Goldman’s stock price is going to dwarf any change in GE’s. This is despite the fact that GE is close to three times the size of Goldman as measured by market size, at $269 billion versus Goldman’s $98 billion.
The method and the narrow number of stocks included is why many look to other gauges for market health, like the S&P 500. This index is weighted by the market size of the largest 500 companies in the country. In that calculation, the largest companies have the most impact. The emphasis on the larger companies may provide a better measure of market performance. With about 3,700 publicly traded stocks in the U.S., the Russell 3000 covers most of the investable stocks and is the broadest index.
So What Does it Mean That All of These Indices Are Reaching New Highs?
It means that now is a great time to review your risk tolerance and asset allocation. There is no doubt that markets will have downs as well as ups. There is no return in the markets without taking on risk. When an investor is lucky enough to have a return, as many do now, it may be time, depending on your circumstances, to take some of your money out of the market if you are risk adverse or getting that much closer to retirement.