Rick Bloom Talks Money

The Dow Jones, Explained

Episode Notes

In today's episode, Rick Bloom is joined by Bloom Asset Management team member Jack Riashi, Jr, to answer listener questions about the Dow Jones Indusrial Average, or DJIA.

We start with the misnomer that is "industrial average."  The Dow may have started that way, but Jack explains why it's not really "industrial" anymore.  Also, the index is an average of only thirty industry leading companies.

Next, Jack and Rick explain how the Dow Jones Industrial Average is calculated, and how that compares to other indexes.  They also cover how - and why - the Dow changes.  What does that mean for companies that are added or removed?

In fact, three companies were recently removed from The Dow - Exxon, Raytheon, and Pfizer. They were replaced by Amgen, Salesforce, and Honeywell. Jack and Rick talk about what that means.

In terms of practical use, Jack explains how everyday investors should use The Dow.  We cover the dangers of basing a porfolio around one index, and we discuss why percentage is more important than points.

As always, Rick answers listener questions from you. This time, he starts with an email regarding bank accounts' FDIC insurance and interest rates.

Rick also answers listener emails regarding withdrawing retirement funds and Coronavirus-related exceptions in 2020, as well as fees advisors charge.

Resoiurces:

Bankrate: https://www.bankrate.com/

As always, if you have a question for Rick, you can email him at:

Rick@RickBloomTalksMoney.com

Find Bloom Asset Management on the web at http://www.bloomassetmanagement.com/

Episode Transcription

Rick Bloom Talks Money Episode 10 - Dow Jones Explained

Rick: Welcome. I'm Rick. Bluman welcome to Rick bloom talks money. I'm an attorney certified public accountant financial advisor. The goal of our podcast is real simple. Help you make better decisions with your money. Cause I believe money looks better in your pocket than it does anywhere else. Independent financial advice.

That's where you're going to get from this podcast all the time. And also we're only going to speak in English. Simple, understandable terms. If you ever have any questions you want me to answer on the air or comments on the show or topics you want me to consider? All you have to do is email me, Rick at Rick Blum talks, money.com and some of the future shows we're going to do based upon your requests.

We had a question on Medicare dividend growth fees. We're going to have all those topics in the future. Today's topic came about because of an email received, asked me about the Dow Jones industrial average. So that's our topic today, the Dow, what it is, how you should use it. And with me is Jack . Jack is a CFP.

He works with me at bloom asset management. He sits on our investment committee. He's very actively involved in managing our portfolios, all our strategies. And there's probably no one more passionate about the market than a Jack rashy. So Jack, thanks so much for joining us today. 

Jack: Great to be on your show.

Rick: It's great to have you Jack, and I guess right off the bat, starting off the Dow Jones, industrial average. It really is not an industrial average anymore. Is 

Jack: it started off early going when it was created in 1896. And it was essentially all industrials at that point, but obviously through the years, and certainly more recently, probably in the last 30 years, the average has really gotten away from industrial sort of focus that has really diversified into.

A lot of other areas, technology is actually the highest weighted sector in the, industrial average, which is really interesting. I'm not sure how many of your listeners know that healthcare would be like number two. So it has really diversified over the years. So industrial is probably a misnomer on that.

It's not the correct description. If you just read the Dow Jones, industrial average, it's really not. And industrial average anymore. 

Rick: To me, it's just paying huh. Image to the past, and that's what it's called. And that's what they're going to continue to call it. But there's a lesson to learn for investors.

Just because something calls themselves, that doesn't mean they're actually what it is. And I use this example with mutual funds over the years, you read the name of a mutual fund, and then you look at its portfolio. It's really two separate things. So as investors don't get caught up with investment, what they call themselves, what their names is, actually look at what they're doing.

Look at their portfolio because Jack's right. The Dow Jones, industrial average is not an industrial average anymore. So when we look at the Dow, Jack, it is by far the most popular index, everyone quotes the doubt, but so few people really understand what the Dow is. So can you explain what is the Dow supposed to measure?

Jack: Measure the market. it does reflect, it's supposed to, that was the idea behind it when it was CRE when it was created, it was mostly industrial. So it was at that time, our economy was mostly industrial, railroads and shipping it again, it's morphed into something different, but it is supposed to reflect the market.

It's supposed to reflect the economy. And I think that has done that. I think it's improved. with some of these changes, adding some of these different sectors of the economy, it does reflect what is happening. It's just not, with 30 holdings in the index, it doesn't have the same importance as the S and P 500, which has 500 companies.

That's probably a better reflection. Of the economy and markets, as opposed to the Dow Jones, but it is supposed to be a barometer. I believe it does do that fairly well. 

Rick: A barometer of the overall us stock market. And you brought up something Jack, that's important for people to understand. There are only 30 stocks that are computed into the Dow.

So there are well over 5,000 listed us companies. But only 30 of them are part of the doubt. And all these companies are leaders in their industries, companies like United health, home Depot, Microsoft, Apple, Boeing, 3m Johnson, and Johnson. Most people know all the companies in the Dow, but it is important to remember.

It's only 30 companies and they're all industry leaders. So they really don't reflect any smaller listed companies on the market. 

Jack: They don't. These are, some of the largest companies there, again, the well known names. Coca-Cola, you have IBM, Nike was added a six or seven years ago, Intel 

Rick: they're behemoth companies.

Jack: They're behind that. They're supposed to. Primarily have revenues in the United States. if you look at the companies, India index, a lot of them are global. Coca Cola, Microsoft, Nike, a lot of their businesses done overseas. So I'm not sure if that criteria still applies necessarily the averages committee who gets together and tries to figure out what companies they should add to the index.

I don't know if that's. just having revenues in the U S if that's something that they continue to look at. because these companies are global in nature. 

Rick: the reality is it used to be that's where most companies got their revenues from the United States. And that is no longer true.

As you mentioned, Jack, when you look at companies like Apple and Coke, A lot of their revenues come from abroad. So the Dow has changed along with our economy. And that makes sense. The economy 50 years ago is not the economy today. And so the Dow is constantly, changing Jack. Can you tell us how the Dow is calculated?

How do they come up with these numbers? 

Jack: Yeah, that's an interesting one, right? When it started off in 1896, when they have 12 companies in the Dow back then it was very easy to calculate. You just take the 12 companies, you add up all their share prices divided by 12. that was the index. It was like that I think until about, I think 1928, when they added, I think 20 companies and then.

from there because of Sox, bullets, and dividends, jurors of companies, that divisor has changed through the years. it's no longer, yeah. You take 30 companies add up all their stock prices, divide by 30. You can't do that because of all the adjustments. So now it's a divisor that, that the committee has come up with.

I think it's. Like 0.1, four something there's a fractional amount. So you'd sum up all of the shares of the companies on the index and you divide that sum by the divisor and you get the index level of the doll. 

Rick: And what I think it's important for people to realize is when they do the calculations of the Dow Jones, It's different than when they do the S and P or the NASDAQ, because it's based upon share price, not market value.

And that's where the doubt really is different than any other index. 

Jack: It's unique. It's unique in that way. There really isn't another popular index or equity index that I'm aware of that just uses the price of the company as the barometer, as the. Calculation on the index itself. that's why, as an example, like when Apple split four, for one, they went from, $600 a share that back down to about 125, I think is where they're at right now.

because they split, their position in the index drop from being number one, literally to now I think they're like number 17 and the index, even though the company is worth nearly $2 million. in market cap. So they're, they have a very high weighting in the S and P 500. They're one of the, I think the largest, actually the S and P 500, the Dow they've fallen back down to 17, which is interesting, but that's just based on 

Rick: price and that's the way the Dow has done it.

Now, personally, in my 35 plus years in the business, no one has been able to explain to me why stock price is important versus market value in the differences market value is. You take what the stock is selling for multiply by outstanding shares. And that's what a company is worth, but the Dow does stock price and their divisor kind of compensates.

But the reality about the Dow is at least they calculate it the same way. So you can look at it historically and see how the Dow has performed to give you that general barometer of us markets, Jack. We saw a recent change. And we're going to talk about the change just in a minute. But my first question is in that regard is how often does the Dow change?

People think that the Dow doesn't change, but it's constantly changing. Isn't it? 

Jack: It has changed. It's interesting. From 1940, I saw the staff from 1940 to 1981, thoroughly six changes to the Dow Jones, industrial average. It's incredible. Only six changes for now since 81, there's been, almost doubling, quadrupling of those changes.

we've had about 60 changes to the Dow since its inception. It's about a change every couple of years to the Dow. And again, a lot of it has happened after 1980. 

Rick: I think it reflects how our economy is changing. Our economy has changed. Not only we are a global economy, but we're much more information technology economy.

And so for the Dow to be relevant, it also has to, change over time. So from an investor standpoint, just because the Dow makes a change, people shouldn't read too much into that because it is normal for the Dow to change. 

Jack: it is normal. I think he used to be when a company was added to the Dao, that was a big deal.

it was a, wow, this is a graduation into the big time, I'm in the Dow Jones, industrial. This is, There have been a lot of theories about there. There've been theories that when a company is added to the Dow. That it tends not to perform very well after it's added to the doubt.

I'm not sure if that's true or not. You have a lot of great companies in the Dow that have been added. Nike, for example, has done very well since it's been added to the dowel. So I don't know how truthful that is, a lot of these companies who get into the Dow. Are already established through either on the S and P 500 during the NASDAQ.

So it's not as big a deal anymore, 

Rick: just because company companies leaving the Dow don't think that they're going out of business. It doesn't mean that whatsoever. And a lot of studies show when a company leaves the Dow, they actually perform very well. Jack. We had a major change last week in the, the Dow Jones industrial average.

And maybe you could tell us what those changes. We're 

Jack: three companies were removed Exxon Pfizer and Raytheon, and they're replaced. Usually when they, obviously if they're taking three out, they're going to replace them with three new companies. So the three new companies added were Amgen.

Salesforce and Honeywell and Jen, of course, being a big biotech, pharmaceutical Salesforce being in the technology industry and Honeywell, in a sense through technology slash industrial slash consumer, they're very diversified, right? 

Rick: Honeywell's a little bit of everything. And the reason for the change, which they mentioned was the fact that Apple split four to one, as you mentioned, Apple is selling for about $500 a share before the split.

And they were the number one component in the Dow, which means when they moved up or down, it affected the Dow more than anything, but with their four, for one split, instead of having a 12% share they're down to about 3%. And so the people that run the Dow felt that since information technology, such a major part in.

If our economy, they had to make these changes. So if it wasn't for the Apple split, we may not have seen these changes in the Dow, 

Jack: it's possible. I know, Exxon Pfizer, their stock prices have not done very well. Exxon's been in the. In the index for, Oh my gosh. decades, they started a standard oil of New Jersey.

So it's, 

Rick: I wouldn't be surprised of Exxon has been in for a hundred years. 

Jack: It hasn't been for a hundred years, obviously with energy declining oil prices, it, and they've been having issues, So they've, they do look at that. They do look at that as well. 

Rick: The reality Jack is energy is no longer.

A major part of our economy. Like it used to be, it's being replaced by things like technology and healthcare and for the doubt to stay relevant, they're going to have to make changes. That's right. 

Jack: So they've been very active and now there's only one energy holding Chevron in the index at this point.

Rick: And that's surprising. It is you don't check when people look at the Dow. I think they should look at it from a couple of different ways. One as. an investor in general, but one also from looking at their portfolio. So from an investor in general, how do you recommend people use the Dow?

Jack: as an investor, again, as a barometer, I think it's a good barometer to use. It's the most well known. It's the one that's always talked about in the news. The Dow did this, the doubted that it went up by 2000, it went down by 500. So I think it's good from that standpoint, from an investor, who's constructing a portfolio.

that's building a portfolio, at our firm, we never really build portfolios to indexes. That's one of the fallacies that people think, you don't start with an index and build a portfolio is building a portfolio based upon, your goals and objectives. So if you have a, a stock and bond portfolio of a stock portion of that portfolio, so Oz, we never measure the growth side of it.

The portfolio of the Dow Jones. for us, it's always either an asset P for example, or a global index. Of course, there's also the bond part of the portfolio. So unless you have a hundred percent of your portfolio in equities, which we don't recommend, we recommend it balanced portfolio, measuring any portfolio too.

A stock index is not. Appropriate because you're not going to be a hundred percent invested in stocks 

Rick: about that. And when you measure to an index again, it's limited the Dow 30 companies. Yeah. S and P 500, and you have to be much more diversified than that. So I agree with you, Jack. I think from. Looking at the economy in general, you should look at the Dow and look at the trend that it'll give you an idea of where markets are going, but I don't think there's one index that you can get a total picture from.

You have to look at. A number of different indexes and the dowel is just one piece of the puzzle, but it does give you an idea. Look at the trend and from an individual portfolio standpoint, I always tell people it relatively is immaterial. Whether the Dow goes up or down may have no impact on your portfolio.

I think also Jack, where sometimes people make mistakes. They look at. The points that the market moves as opposed to the percentages. And I use this as an example. I remember you go back to 1987 black Monday, and the Dow dropped a little over 500 points and the market crashed. That was 23%. Of the portfolio, the largest percent drop well today, if it drops a 500 points, it's less than a 2%.

So I think that's what people should pay attention to as opposed to the points movement. But I think too many people pay attention to. How many points the market moves up or down? 

Jack: Yeah, that's been an issue, I think for a long time. I think it's almost the same, Rick, really with portfolios, I think, clients or investors that look at their portfolios, they look at the dollar drop or their portfolio, but they may not necessarily know the percentage decline or at least their year to Tate return.

you have a large decline in the Dow, for example, and again, 500 points, even a thousand points. May not really mean much in any given day. Certainly 23% was gigantic drop. In 87. 

Rick: I remember that day. I remember that day, but I'll tell you where things have changed. Most people didn't know the stock market crash until they came home and watched the news because we didn't have the internet.

We didn't have 24 hour cable. And just to point things in perspective, back in March, we had a day where we were down nearly 3000 points on the doubt. And that was the largest point drop. But when you look at the percentage drop, it was 13%, which is not good, but it's certainly not like the 23% we saw 1986.

Jack: Yeah. I think that same month of March we had. The largest point drop. And I think we have the largest point increase, I think in the same month, I think within two or three weeks, 

Rick: we did, we had a 2100 point increase. I think that was a, the 24th of March, actually. 

Jack: That's right. That's exactly right. It was right after they announced the government stimulus package.

And so that was the largest. point increase and, we've risen, since that time it's almost again near record high until the last couple of days. 

Rick: And I always say don't let one or two days dictate your, investment decisions because it doesn't make sense. And again, I think the key is when you look at the Dow, how you use the Dow, it is just a tool and it provides the trend.

But no one should make portfolio decisions based upon where the Dow is in any given point in time, you do not manage your portfolio based upon an index, you use your goals and objectives. That is really what is going to, make you a successful investor. Jack, any final thoughts on what you think of the Dow, how investors should use it?

And maybe even address some of the issues at critics say about the Dow because it's price weighted, not market cap. 

Jack: Yes. as far as the doubt goes, it'll always continue to be a barometer. I don't think that's going to go away. it's been around for 124 years. I think it'll continue to stay around, the criticisms of the Dow.

there've been a lot of criticisms about, should they increase the number of holdings to, there was talk about increasing at the 50. There was talk about moving it to a market cap, weighted similar to the S and P 500 and the NASDAQ. But I think they've paused it, that the average is committee.

I think they're really taking a, more of a cautious view of that. I'm sure they're thinking about it, but I think moving pretty slowly on some of those changes. I think they want to keep the historical characteristics of that index in place. And they want to keep it special and unique.

And I think from that standpoint, I think they're going to really move slowly. They'll pay. They'll continue to make changes. I'm sure. To the components of the average. To maybe make it more relevant to the current economy, but I think expanding it and moving to market cap, I think those changes that's going to be really tough.

I doubt they'll do that in the 

Rick: near future. I agree with you, Jack. I think the components may change, but you're not going to change over the 30 stock. Just want to give you an idea how the Dow has grown over the years. Back in 1995. That is when the Dow first pass 5,000 1999 is when it surpassed 10,000.

2013, 15,000, 2017, it past 20,000 and in 2018, it went to 25,000. And I think it gives you the remembrance that the longer you're in the market, the better you're going to do. So if you think about in 1995, only 25 years ago, the Dow was at 5,000. And now we're over 28,000. So it's been an incredible run and it's something that I think people should pay attention to use it as a trend, but don't use it to manage your individual, portfolio just doesn't make sense, Jack.

Thanks so much for, joining us today and thanks for your comments. 

Jack: Thank you, Rick. I appreciate it. Great to be on the show. 

Rick: What I want to do now is get to, some of your questions like we do every podcast. And remember if you have questions for the podcast, Rick, at Rick Blum talks, money.com. This is from Joe.

Hi, Rick. Hope you're doing well. I am. Thank you. I really enjoy your podcast. Thank you. Excellent selections. I've learned a lot from you and your subject matter experts. Had a question that may not be too common. Not sure if the top is podcast worthy. Any topic is podcasts worthy, family settling, large Lake home, not buying another home.

And do not have any major bills, is it true? That bank counts are only insured by the government up to a hundred thousand dollars. Family's worried about risk. Also realize that bank accounts, low interest rates. first of all, Joe, you should know that a few years ago, the F D I C raised the limit to $250,000.

So you're protected up to $250,000 and that's basically in every institution. So if you have more than that, what you can do is use two different banks or even three different banks. Then you have full insurance. Now, interest rates are low with the banks and they're going to stay low for a while. The federal reserve has given every indication.

That interest rates are going to mean low, but what you can do is to shop rates around. You'd be surprised, particularly if you use internet banks, you may find that they pay a substantially higher rate of return. One of the websites I like is bank rate.com. Because they have only federally insured institution.

And I think that is the key. When you go into a CD, a money market account, something of that nature, you really want to make sure that they're federally insured. So that's what I would do on the other hand, Joe, if you don't need the money for longterm, I would consider a market based portfolio, maybe dollar cost average into the market.

You want to stay diversified, but keeping a lot of money in cash these days really is not a conservative way of going because when you look at the return on cash and then you factor in the taxes, your money is not keeping up with the increased cost of living. So I always believe you need to keep an emergency fund of money.

But you don't want to leave too much money in the bank, but if you do shop around using internet bank, Oh, and you may find that you're getting much greater rates of return. This is from Dave. My plan is retired at the end of the year. Congratulations, Dave from FCA will have just turned 59 years old. My question is will the 10% early withdrawal penalty apply to me by separate from the company age 59 and make a withdrawal from my account before age 59 and a half.

I very much enjoy listening to your podcast. I very much enjoy you being there, Dave, first of all, yes, we do have the 10% penalty. If you withdraw before 59 and a half, however. This year, there's an exception to the rule because of the Corona virus. You can take up to a hundred thousand dollars without paying a penalty, as long as it's related to the Corona virus.

So if you're retiring early, if someone in your family had the Corona virus, you really have the opportunity to take out that a hundred thousand dollars. And one of the nice things about that is. You have three years to pay it back. If you decide that for some reason down the road, you didn't want to take that money.

You have three years to pay it back. But the key is if it's Corona virus related and the IRS has been very generous on that and very liberal in what is Corona virus related? This is a, from Dennis. Hi, Rick. I really enjoy your podcast. Great info. Can you do a segment on fees? I have an advisory charges, 1.6, my return lags all my other investments.

I'm thinking of making a change. I'd like your opinion. I believe dentist's fees are extremely important and that is a great topic for a podcast and we will do one just dedicated all the different fees that some financial advisory firms charge. I'm a big believer in low cost investing for as long as I've been in the investment world, I can tell you low costs equals higher returns.

And I think it's one of the mistakes that investors do. Investors don't focus on fees and they should. There is a huge difference in different mutual fund companies. When they have their internal fees, their management fees. Sometimes you see companies like Vanguard under 1%, sometimes even a half a percent.

And then you see other mutual funds that are one and a half and 2%. It's crazy. You have to focus on fees. Fees are important, low fees, equal higher returns. That being said from an advisor, Dennis, I think the 1.6% is high. I know at blue mats at management, our general fee is 1%. 1.6% seems to be high for me.

And I'll tell you this. I think it's a fair conversation to have with your professionals, no matter what they are, whether it's your doctor, your lawyer, your phone, financial advisor fees, do matter. And one of the things about investors is sometimes they're dealing with advisors that not only charge them a fee to manage their portfolio, they're also taking commissions and other types of remuneration.

And that's something you gotta be cautious about. My view is I always want to deal with someone who's fee only. And there are different types of advisor, but fee only charge you a fee for their services. And it's upfront the problem with so many people in the financial world. All the fees are hidden.

They don't disclose them very well. And to me, if someone gets a free trip by selling you a product, that's just another feat. Who do you think is paying for that vacation? It's you? So this is an extremely important Dave fees do matter. They are relevant. And I'll tell you this. If a financial advisor tells you that you don't pay his fees, you're paying a lot more fees than you should.

If you want to be a good investor, you have to focus on fees on that note. Want to thank you for joining me on our podcast. Want to remind you if you have any questions, any topics you want me to cover? Just email me, Rick at. Rick bloom talks, money.com. Thanks so much for the company today. I enjoyed it.

Hope you did too. Bye. Now, podcast is brought to you by bloom asset management, building financial futures. Since 1984. Bloom asset management is a fee only investment management and advice firm with its team of expert financial legal and tax professionals. You can be sure that bloom asset management will be your longterm partner in building your financial future.