The Essentials
At a Glance
- A point move means little on its own; the percentage change is what matters.
- The S&P 500, the Dow and the Nasdaq measure different slices of the market differently.
- One day's move rarely changes anything for a plan measured in decades.
The Dow fell 500 points today. Is that a lot? It depends entirely on a number the headline did not mention: where the Dow stood at the start of the day. Market headlines are written to be read quickly, and they tend to lead with whatever sounds largest. Reading them well takes a few habits of translation.
Points versus percentages
An index is a single number that summarizes the combined prices of a group of stocks. The absolute level of that number is arbitrary. It depends on when the index began and how it was constructed, and it carries no information on its own.
What carries information is the percentage change. A 500-point move in an index at 10,000 is a 5% move, which is large. The same 500 points in an index at 40,000 is 1.25%, a fairly ordinary day. As indexes rise over the decades, the same percentage move produces ever larger point moves, which is why the biggest point drop ever is reported far more often than the biggest percentage drop ever.
The habit to build is simple. When you see points, look for the percentage. If the headline does not give it, the number is not yet meaningful.
Which market the headline means
When a headline says the market rose or fell, it almost always refers to one of three United States stock indexes: the S&P 500, the Dow Jones Industrial Average, or the Nasdaq Composite. They are often reported together and usually move in the same direction, but they measure different things and sometimes diverge sharply.
None of them is the whole market. Thousands of companies trade in the United States, and many more abroad. Bonds, real estate and other assets are not in any of these indexes at all. The market in a headline is shorthand for a slice of the stock market, and a diversified portfolio may bear only a loose resemblance to it.
How the three major indexes are built
The S&P 500 tracks roughly five hundred large companies chosen to represent the broad economy. It is market-capitalization weighted, meaning each company's influence is proportional to its total market value. A company worth ten times as much as another counts ten times as much in the index. This makes the S&P 500 a reasonable measure of where large-company money is, but it also means a handful of very large companies can drive much of its movement.
The Dow is far narrower, containing about thirty large, established companies selected by a committee. It is price weighted, an older and more peculiar method: a company with a higher share price counts more, regardless of the company's actual size. A stock trading at $400 has ten times the influence of one trading at $40, even if the second company is worth more. The Dow is still widely reported because of its long history, but its construction makes it a rougher gauge.
The Nasdaq Composite includes the thousands of companies listed on one particular exchange. It is also capitalization weighted, but its membership is heavily tilted toward technology and growth-oriented businesses. When those sectors move, the Nasdaq tends to move more than the other two.
The word breadth describes how many of an index's members are participating in a move. A day when the index rises because a few giants rose, while most members fell, has narrow breadth and tells a different story than a day when nearly everything rose together.
Record highs and worst days
A record high sounds momentous, but it is a mathematical inevitability for any index that has risen over time. Because indexes have historically trended upward over long periods, records are common. A record high says the index is higher than it has ever been. It does not say that a decline is imminent, nor that one is not.
A worst-day-since comparison measures a decline against a past one, and it is only as meaningful as the date. The worst day since last month is an ordinary bad day. The worst day since a major crisis is more notable, though even then the phrase describes a single day, not what follows. Two questions put it in proportion: how large was the move in percentage terms, and how far back does the comparison reach?
Why one day rarely matters for a plan
Suppose, for illustration, an investor holds a diversified portfolio worth $1,000,000 that is meant to fund a retirement twenty-five years away. One day the market falls 2%, and the portfolio loses roughly $20,000 in value.
Over the coming twenty-five years, that portfolio passes through thousands of trading days. Some are likely to be worse than this one, and many better. The outcome of the plan depends on the accumulated result of all of them, not on any single day. One day's move, however loud the headline, is a rounding error in that arithmetic.
This does not mean news never matters. It means the proper response to most headlines is to note them, translate them into percentages, and return to the question that actually governs a plan: has anything changed about your goals, your timeline or your circumstances? If not, the headline has already done its work.
Questions to Discuss With Your Advisor
- Which index, if any, is a fair comparison for my portfolio, and why?
- When headlines are alarming, what would need to be true for my plan to change?
- How is my portfolio's performance reported to me, and in what terms?
- How much of my portfolio is exposed to the handful of large companies that drive the major indexes?
