Pointing Investors in the Wrong Direction:
The Problem with Watching the Dow
Headline from the evening of February 5, 2018: Dow Jones Industrial Average falls 1,175 points, the biggest drop in history.
Oh my, the sky is falling! This is catastrophic! My retirement savings have been decimated! But wait a minute – can we put this into a little perspective?
What Does a Drop in the Dow Really Mean for Your Portfolio?
Let’s jump in our time machine and zoom back to December 18, 1899. On that date, the Dow declined by a measly 7.9 points. If you had $100,000 on the morning of February 5, 2018, invested in the Dow versus the same amount invested on December 18, 1899, on which evening would you have been worse off? Your $100,000 at midnight on February 5 would have been worth $95,400, while back in 1899, your portfolio value would have been $88,000 – quite a bit less than in 2018. What gives?
It all boils down to the value of the Dow at the time of the points drop – as the Dow has grown dramatically in value over time, the lower the effect even steep drops have in dollar terms. On December 15, 1899, the Dow was at 66.21, and on the next business day, December 18, it fell the aforementioned 7.9 points to 58.27. That’s a 12% decline in asset value to $88k on your $100k investment. With the Dow so much higher in value in 2018, though, even a more severe points drop – 1,175 on February 5 – isn’t going to sting as much, because the percentage change is much less.
Along these same lines, for those of you who sat watching the tickers on October 19, 1987, the Dow fell 508 points, or less than half of the decline on February 5th of this year. Your loss: 22.61%, again dwarfing the 4.6% drop that occurred this past February 5 in actual percentage terms. That same $100,000 declined, in one day, to just a little more than $77,000.
How Should Investors Read the Dow?
The moral of the story is the Dow, a useful tool for sure, does not provide the ever-important answer to the question, “How much did I win or lose today?” Rather, it is designed to give investors a somewhat permanent record of a price-weighted index of 30 stocks (that changes over time, by the way) that represent the performance of the largest U.S. companies, and ultimately the broader economy.
Due to the power of compounding and the way mathematics simply works, this can be a misleading indicator of what investors should truly care about – where they are now versus where they were at a specific point in time. A helpful way to illustrate this effect is to look at a very long-term chart of the Dow.
Note the bear market of 1987 can barely be distinguished, as the power of long-term favorable returns dramatically overshadows that, and almost all other, bear events.
There is an equal but opposite construct when it is announced that the Dow has reached a new high. On December 15, 2017, it was again announced that the index had attained another ALL-TIME HIGH. True, but relative to the day before it increased by only six-tenths of 1%. Pretty exciting? You can retire now, right?
The point, if not clear by now, is that when investors are watching the media bombastically describing the Dow’s biggest declines or, conversely, heralding its reaching all-time highs, they should try to ignore the points and focus on what this means for what counts – changes in asset values.
Equity Investing is a Marathon, Not a Sprint
It is important for investors to remember that investing in stocks is a long-term game. Spending a gain from a new high or running from a record points decline has to be considered in the context of investors’ specific goals, objectives, time horizons, and tolerances for risk. Markets are cyclical and can be volatile. When the ground starts feeling shaky, employing discipline, good governance practices and portfolio oversight will help investors to the finish line.
Segal Marco Advisors provides consulting advice on asset allocation, investment strategy, manager searches, performance measurement and related issues. The information and opinions herein provided by third parties have been obtained from sources believed to be reliable, but accuracy and completeness cannot be guaranteed. Segal Marco Advisors’ R2 Blog and the data and analysis herein is intended for general education only and not as investment advice. It is not intended for use as a basis for investment decisions, nor should it be construed as advice designed to meet the needs of any particular investor. Please contact Segal Marco Advisors or another qualified investment professional for advice regarding the evaluation of any specific information, opinion, advice, or other content. Of course, on all matters involving legal interpretations and regulatory issues, investors should consult legal counsel.