Market Indexes Aren't Diversified as You Think

It is very common in our industry to compare personal portfolio returns to indexes. Two of the most common indexes referenced are the S&P 500 and the Dow Jones Industrial Average, also known as “The Dow”. Investors compare personal return to indexes, or benchmarks, to give them a sense of whether the portfolio is doing as it should…kind of a check and balance. That is a reasonable use of indexes, but unfortunately many investors are taking it too far. 

The Dow

Selecting Your Investment Benchmark

Investors often compare personal portfolio performance with some stock market index, a benchmark. While the comparison may be easy to make, it is seldom a valid comparison. What we are actually doing is comparing apples to oranges. 

What Dow 20,000 Means

Not much. For the media it means headlines and talking points. For traders and speculators, it may be an excuse to make some trade based on expected short-term outcomes. For investors, it means nothing – except for its potential to distract you from what really matters. 

It’s nice that stock market indexes are increasing, but what does it really matter that the Dow hit 20,000? Sure, it’s a nice round number with lots of zeros. But there is really no difference between the Dow hitting 20,000, 20,126 or 19,944.

What a Year!

This is always a good time for people to look back on the year and take personal inventory.  For investing, the personal inventory often takes the form of behavioral inventory. We cannot control the news, economy or market, but we can control our reactions to external events. So how did you do this year?

Election 2016: Surprise and The Improbable

No matter where you lie on the political spectrum, the outcome of the 2016 election was a surprise to most people. The media got it wrong; the polls got it wrong and even the betting market (where real money is at stake) had the odds of a Clinton win at 80% as the polls opened. States that were sure things ended up flipping with no advanced warning. The markets had priced in a Clinton win. As usual, when the market prices in one thing and something else occurs, it gets surprised and needs to re-price.

Expected Returns

One of the core inputs required in the financial planning process is the assumption of what the future return of the security (portfolio) will be. Obviously higher returns are preferable because they translate into greater spending power and/or reaching your goals sooner. Yet higher returns come with a caveat; higher risk. There is a very strong correlation between risk and return. So the higher the desired return, the greater the risk of losing money over a period of time.