The Dow Jones Industrial Average recently hit a level not seen since October 2007. Should that affect your investment decisions?
Depending on how you're wired, your emotions might go one of two directions. You might think you're missing out on the action and better invest more in the market before it goes even higher. Or you might think the opposite: At this lofty level, it can't last much longer. Better bail before that happens.
Commentators talk about the "psychological barrier level" that the Dow crossed, but what's perception and what's reality?
Here are some facts to keep in mind before letting the Dow level dictate your financial activities:
It's only one index — and it's not representative of the overall market. The Dow tracks only 30 "blue-chip" companies and for a variety of reasons excludes some of the most valuable American companies (Apple, Amazon, Google) while including companies worth far less (Alcoa, which has been trading at under $10 a share).
By contrast, the Standard and Poor's 500 includes — you guessed it — 500 separate companies and therefore is a statistically more valuable indicator of overall stock trends. Part of the reason the Dow is followed closely is that it's the oldest index — created in 1896 — but for the same reason, its results are skewed by its dated computational methodology.
Remember the Nasdaq — or not. If you were paying attention to the stock market in the heady days of the tech bubble, you may remember seeing the Nasdaq climb to record levels. Investors were excited about the so-called "New Economy" and believed that the tech-heavy Nasdaq was the place to invest. The index doubled in value in a year and at its peak in March 2000 reached 5,132.
But as reality dawned on investors that many of the companies of the dot-com revolution were propped up by venture capitalists rather than revenue streams, the bubble burst. By October 2002, the Nasdaq bottomed out at 1,108. This year as the Dow was reaching 14,000, the Nasdaq was at about 3,200.
Investing requires a long view. The takeaway here is not that you should run the other way when an index hits a new high nor should you let the escalating prices be a reason to invest everything in the market. Rather, you need to look closely at both the overall economic reality and what developments, if any, may require a change in your financial plan.
The financial world is far too complex to be summarized by a single figure. Even a close study of all the widely followed economic indicators — gross domestic product, consumer confidence levels, unemployment levels, housing starts, wholesale prices, balance of trade — can only hint at the economy's current status.
Investment decisions should not be based on emotion or a single event. If you've diversified your investments among a wide array of holdings, you've taken the most important action possible as an individual investor. If you're unnerved by the news of the Dow hitting such high levels, you may want to meet with your financial adviser to ensure your mix of investments is in line with your risk tolerance and your long-term financial goals.
Brian Fields, CFP, is a branch director at RBC Wealth Management in Lemoyne.
The information included in this article is not intended to be used as the primary basis for making investment decisions nor should it be construed as a recommendation to buy or sell any specific security. RBC Wealth Management does not endorse this organization or publication. Consult your investment professional for additional information and guidance. RBC Wealth Management does not provide tax or legal advice.