What is it about big, round numbers that excites us? As of this writing, folks are once again obsessed with a new potential milestone for the Dow Jones industrial average: 20,000!
Although I am forced to report on it on a daily basis, I think the Dow is perhaps the least meaningful U.S. stock index available. Sure, it’s got history on its side — it was created by Charles Dow in 1896, in order to provide investors with a snapshot of how the overall stock market was doing. But for an index that is supposed to provide investors with a big-picture view, it includes just 30 large companies. And considering that Amazon, Google and Facebook are not part of the Dow, it is hard to make the case that it reflects the broader market.
Besides its limited size and scope, there’s another big problem with the Dow: The way the average is calculated makes no sense. The index is “price-weighted,” which means that the company with the highest price per share carries the most weight in calculating the daily index value, while the company with the lowest price per share carries the least weight. Because of this method, the daily performance of an expensive Dow stock, like Goldman Sachs, can have an outsized impact on the whole index. That’s why professional investors do not look at the Dow to determine what’s going on in the U.S. stock market; instead they use the Standard & Poor’s 500 index or the Wilshire 5000, both of which use a different methodology based on market capitalization (number of shares outstanding multiplied by the price) of a company, to determine the index’s value.
Despite the inadequacy of the index itself, focusing on any index does not change anything in your financial life. I recently asked you to consider a concrete and achievable financial resolution: not to muck around with your portfolio, to avoid timing the market and to instead get back to the more important financial issues at hand.
A number of you wrote and asked to expand on the list of potential financial resolutions to consider. These ideas are not new, but like recommendations about diet and exercise, the tried-and-true advice holds up over time. Here is a baker’s dozen list of potential financial resolutions:
- Track where your money goes.
- Automate bill paying.
- Go to AnnualCreditReport.com and review and correct your credit report.
- Focus on identity theft protection. Change passwords; install firewalls and virus detection software; shred unwanted financial documents; and store personal information in a safe, secure place.
- Pay down consumer debt (credit card, auto loans).
- Create an adequate emergency reserve fund (six to 12 months’ worth of expenses; 12 to 24 months’ worth for retirees).
- Maximize retirement contributions. You may contribute up to $18,000 for 401(k), 403(b) and 457 plans, with an additional $6,000 catch-up contribution available if you are older than 50, and $5,500 for IRAs, with an additional $1,000 catch-up contribution. Enroll in auto rebalancing and auto escalation, if possible.
- Diversify your portfolio with an asset allocation that is consistent with your time horizon and risk tolerance level.
- Draft or update your will, power of attorney, health care proxy and other estate documents.
- Review insurance coverage (life, disability, long-term care and property and casualty).
- Consider refinancing your mortgage. In December, the Federal Reserve raised rates by a quarter of a point and is on track to continue doing so this year. Mortgage rates have already started to rise, but they are still at historically low levels.
- Consider funding a 529 plan for college expenses.
- Have the “money talk” with spouse/kids/parents.