Written by Dimensional Fund Advisors.
A quick online search for “Dow rallies 500 points” yields a cascade of news stories with similar titles, as does a similar search for “Dow drops 500 points.”
These types of headlines may make little sense to some investors, given that a “point” for the Dow and what it means to an individual’s portfolio may be unclear. The potential for misunderstanding also exists among even experienced market participants, given that index levels have risen over time and potential emotional anchors, such as a 500-point move, do not have the same impact on performance as they used to. With this in mind, we examine what a point move in the Dow means and the impact it may have on an investment portfolio.
IMPACT OF INDEX CONSTRUCTION
The Dow Jones Industrial Average was first calculated in 1896 and currently consists of 30 large cap US stocks. The Dow is a price-weighted index, which is different than more common market capitalization-weighted indices.
An example may help put this difference in weighting methodology in perspective. Consider two companies that have a total market capitalization of $1,000. Company A has 1,000 shares outstanding that trade at $1 each, and Company B has 100 shares outstanding that trade at $10 each. In a market capitalization-weighted index, both companies would have the same weight since their total market caps are the same. However, in a price-weighted index, Company B would have a larger weight due to its higher stock price. This means that changes in Company B’s stock would be more impactful to a price-weighted index than they would be to a market cap-weighted index.
Written by Timothy Bock.
Dimensional’s Co-CEO and Chief Investment Officer answers questions about investment returns, benchmarks, and evaluating managers.
Investors often start the year by evaluating how their portfolios have performed. Gerard O’Reilly recently sat down with Scott Mardy, a Vice President and Investment Strategist with the firm, to talk about what investors should consider when evaluating investment performance.
- Your performance evaluation framework should answer a simple question: Has your money manager delivered what they committed to deliver?
- The point of analyzing performance data is to help investors make informed investment decisions. The noisier the data, the weaker the inferences you can make.
- If you’re going to invest time understanding how a manager operates and potentially commit assets to them, you want a manager who is as committed to the long term as you are.
- Over short time periods, outperforming or underperforming a benchmark is not necessarily evidence that a manager failed to deliver what they said they would deliver.
- There’s no magic time frame for considering returns—different time frames provide different information.
Written by Timothy Bock.
A Question of Equilibrium
“Sellers were out in force on the market today after negative news on the economy.” It’s a common line in TV finance reports. But have you ever wondered who is buying if so many people are selling?
The notion that sellers can outnumber buyers on down days doesn’t make sense. What the newscasters should say, of course, is that prices adjusted lower because would-be buyers weren’t prepared to pay the former price.
Written by Larry Swedroe.
Passive investing has been ridiculed by Wall Street for decades. The following list is just a small sample of the criticisms I’ve collected over the years:
- Sanford C. Bernstein & Co. strategist Inigo Fraser-Jenkins called it worse than Marxism.
- David Smith, fund manager at Hargreaves Lansdown, called passive investors parasites on the financial system.
- Tim O’Neill, global co-head of Goldman Sachs’ investment management division, warned investors that if passive investing gets too big, the market won't function.
The common theme is that indexing (and passive investing in general) has become such a force that the market’s price discovery function is no longer working properly. Goldman Sachs’ O’Neill has even called passive investing a “potential bubble machine.”
Given the number of questions I get from investors about this issue, one would think that passive investing is now dominating markets. Let’s see if there’s any truth to such beliefs, and whether there’s anything to worry about.