Q: I just heard that GE is being dropped from the Dow Jones average and being replaced with Walgreens. Unless they are selling at the same price when the change is made, won’t that throw off all the stock prices? – Scott (via Facebook)
A: Scott, I appreciate your question because I think it brings a common misunderstanding to light. While it seems like the world is constantly gauging how well the stock market does by quoting the Dow Jones Industrial Average, the fact is that the Dow is just a weighted average of 30 companies that are traded on the New York Stock Exchange (NYSE) and the NASDAQ. For reference, about 2,800 companies are traded on the NYSE alone, with another 3,300+ on the NASDAQ. So the popular conception that the Dow is a proxy for the entire market is far from correct. It’s just the most convenient.
As of my writing this column, GE is trading in the area of $13/share, while Walgreens is around $67. So since the Dow is based on the stock prices of their 30 included companies, this swap will indeed affect the Dow. And it will likely cause GE stock to drop and Walgreens to rise. But it will not have a dramatic or far-reaching affect on the broader stock market or the other 6,100 companies that trade on the NYSE or NASDAQ.
Rather than looking at the Dow to see how your stocks are doing, I would suggest that you enter the ticker symbols for your various stocks and mutual funds into any number of tracking apps that will save them for you in a personal portfolio for a quick and any-time overview. Some of the most well-known of these apps include Personal Capital, Wealth Management, or Ticker. Or, if you’re looking for an index to see how the market is doing overall, bear in mind that the Dow represents only about a quarter of the value of the US Stock market, whereas an index like the S&P 500 represents about 80%. And the extremely diverse Wilshire 5000 is comprehensive enough to be called the “total market index”, although quotes for the Wilshire are harder to find.
Q: I want to make sure my portfolio is balanced, which I assume means I should include bonds. What should I be looking for? – Madalyn (via email)
A: Ah, bonds. Boring, poorly-understood, under-performing bonds. For the record, I’m stating perception there, not fact. Bonds are none of the above, and should absolutely be included in any well-balanced portfolio. The questions are what kinds, and how much.
Bonds get a bad rap for one very simple reason. That being the general belief that bond prices tend to be inversely related to stock prices. This would mean that when bond prices are up, the stock market may be dropping. And no one likes days like that! In addition, you’ve often heard me talk about the average 7% annual return that stocks have provided since the end of the Great Depression. So if stocks have been going up for the last 80 years, doesn’t that mean bonds have been going down for just as long?
No. And the reason for that is that this inverse relationship – while popularly believed – is not actually normal or healthy for the economy in the long-term. If you don’t believe me, do a search for a graph showing stock and bond returns in the long-term. I’ll bet you my favorite dollar that while you’ll see bonds being out-performed by stocks, you’ll also see stocks and bonds going up and down at roughly the same time.
So Madalyn, back to your original question; if I were you, I’d be looking for an exchange-traded fund (EFT) that owns a variety of municipal bonds, or “munis”. The interest on a muni is exempt from federal income tax, and from state tax as well IF you live in the state where it was issued. And by using an EFT, you will be able to sell it much quicker and easier. As for how much, the percentage of your portfolio in bonds should increase from around 20% when you’re 30, up to around 70% or 80% in your 80’s and 90’s.
If YOU have a question for Ask Eric, tweet it to @AskEricKSUN, send an e-mail to AskEric@mail.com, or like “AskEric” on Facebook.
— Eric Litwiller has spent the last seven years of his professional career helping people achieve their financial goals through the use of budgets, retirement vehicles, and estate planning options. He is a firm believer in the importance of using Earthly riches to fulfill a mission of Christian stewardship. Eric is not a licensed financial planner.