You probably have heard that the Dow Jones Industrial Average topped 20,000 for the first time on January 25, 2017. When a popular index, like the Dow is on a tear, up or down, what does it really mean to you and your investments?
What Is an Index?
First, let’s define what an index is. An index tracks the returns generated by a basket of securities that an indexer has put together to represent (“proxy”) a particular swath of the market. Some of the familiar names among today’s index providers include the S&P, Dow Jones, MSCI, FTSE Russell and Wilshire.
Why Do We Have Indexes?
Over the years, indexes have served two primary purposes for investors: benchmarking and investing.
Benchmarking: A well-built index should provide an approximate benchmark against which to compare your own investment performance … if you ensure it’s a relatively fair, apples-to-apples comparison, and if you remain aware of some of the ways the comparison still may not be perfectly appropriate.Investing: Index funds that replicate indexes allow you to indirectly invest in the same holdings that an index contains, with the intent of earning what the index earns, net of fees.
What Indexes Are NOT
Indexes are NOT predictive. Index milestones (such as “Dow 20,000”) do NOT foretell whether it’s a good or bad time to buy, hold or sell your own investments. Attempting to use current index values as a way to time your entry into or exit from a market does not, and should not impact your well-thought–out investment strategy and savings plan that was established based on your unique investment goals and risk tolerance.
When utilized as they are meant to be, indexes can useful tools for investors. Nonetheless, owning a cost-effective globally diversified portfolio that provides you with the opportunity to capture the returns the market has to offer while minimizing the risks involved AND sticking with that portfolio regardless of arbitrary milestones that an index may achieve along the way is the key to building wealth.