On January 25th of this year, the Dow Jones Industrial Average (DJIA/Dow) passed the 20,000 milestone for the first time ever. Seemingly every media outlet began to host discussions regarding whether investors should get back into the marketplace, how much further stocks can go, and a multitude of other investing-related topics. Even if you have avoided paying attention to the markets and investing in general for years, chances are you likely heard about “Dow 20,000” somehow. Consequently, many individuals are now asking what the implications are and whether this matters.
In 1896, a time when investors primarily purchased bonds and the stock market was not highly regarded, Charles H. Dow and his business partner Edward Jones created the DJIA so that it could be an informative “tool” for gauging performance of the overall stock market and U.S. economy. Since 1928, the index has contained 30 large publicly owned companies based in the United States, all of which are major players in their respective industries. While this makeup may have served as a solid barometer for the overall stock market and economy in the past, this narrow set of stocks is clearly lacking in representation. Additionally, the way in which the index is calculated is problematic, as each stock’s weighting in the index is contingent on its share price regardless of its market capitalization. This means that stocks with higher share prices are given a greater weight in the index, which allows for a single company to significantly boost the overall index.
It is clear that the Dow has lost much of the significance it once had, but it should serve as a reminder to what is important when investing. For example, it is not the absolute share price of a stock that investors should pay attention to, but rather the company’s true value in the marketplace. It is true that strong fourth quarter earnings and the optimism for policy changes following the presidential election were catalysts for the Dow to climb past 20,000. However, these are not the only factors that investors should consider when investing. Investors should remember that it is always important to have a diversified portfolio that is well-equipped to weather any economic environment. Uncertainty will always exist in the financial markets, so having an appropriate investment makeup of equity and fixed income, rather than tracking just 30 stocks of an index such as the Dow, remains a sound investment approach.
