Why the Dow Jones hitting 20K is meaningless

The Dow Jones just recently hit a milestone price of $20,000. While we think this is good, we believe this is nothing to be excited about. Essentially, our lack of enthusiasm over this $20,000 mark comes from how the Dow Jones Industrial Average (DJIA) is calculated.

When the DJIA started in 1896, it was a true average. To find the index price you would simply add all of the stock prices for the companies in the collection and then divide by the number of companies.  Today it’s a little different in that the sum of all of the stock prices is now divided by a number less than 1. Essentially, the index will be larger than the sum of all of the included companies’ stock prices. This divisor fluctuates based on how many stocks are offered as well as when a company is added or removed from the index. Basically, this number will move a lot.

The other issue with the DJIA formula is that it is price weighted. The index rewards large price increase to stocks rather than looking at total market cap. For example, let’s say you have a company that sells 10 shares for $5 each and I have a company selling 100 shares for $0.50 each. Both companies are worth $50. Now let’s say both companies grow 20%. So your company is now selling 10 shares for $6, while my company is selling 100 shares for $0.60. Again, both companies are worth the same amount. However, the DJIA would increase more with your company due to the larger price increase.

Another reason to not get excited over the Dow Jones is that the index only includes 30 companies. This is a very small number in today’s market. Meaning that the Dow Jones would not be representative of what the market is doing as a whole. While there are great companies included in the index, we feel that a larger sample size of corporations would be more reflective of the market.

Overall, we’re not thrilled with the Dow Jones index. However, we understand that there is some emotional value to looking back and saying “wow, I remember when the Dow was at 18,000”. While the Dow Jones hitting 20,000 is definitely a milestone, we recommend using other market indicators like the S&P 500 to get a more accurate representation of how the overall market is performing.

To learn more about the Dow Jones Industrial Average, you can visit their site at http://www.djaverages.com/?go=industrial-overview

Why we focus on net worth

There are many ways of looking at your finances, but none more important than your net worth. Net worth signifies your assets and liabilities, or how much you have versus how much you owe. It shows you a snap shot of your financial worth at a certain point in time. This is the statistic most relevant to the journey of personal finance.

Net worth can be classified as the simple equation:

Assets – Liabilities = Net worth

For example, let’s say we have $50,000 in the bank and $30,000 in student loans, which gives us a net worth of $20,000.

It’s important to focus on and track your net worth as it gives a sense of how you are progressing financially. If your net worth is routinely increasing, that means you are saving more than you spend. Conversely, if your net worth trends downward, you are spending more than you make. Your net worth will fluctuate, don’t get discouraged, there’s always bills and life happens. That’s why net worth is so great, it quickly shows you how well, or poorly, you are doing financially and allows you to correct or improve habits.

Coming out of college it is extremely common to have a negative net worth due to student loan debt. According to the Federal Reserve’s latest Survey of Consumer Finances, approximately 50% of millennials aged 25-29 have a net worth of less than $10,000. About 30% have a negative net worth. While these numbers decrease with higher age groups, showing that net worth typically increases with age, millennials should begin to focus on this statistic now to increase long term quality of life.

The two ways to increase your net worth quickly are to either increase your assets (ie make more money) or decrease your liabilities (ie paying back debt). Since the former can be difficult to increase when you’re new to working world, the best way to increase your net worth is to focus on paying off debt.