What does the Dow Jones Industrial Average hitting the 20,000 level mean for ETFs? The short answer is “nothing.” The long answer is a long-winded way of saying pretty much the same thing, but here it goes: It’s just a number, and as every index and index ETF disclosure says, “you can’t buy an index.” Therefore, even if the index value equated to a price, you couldn’t buy the Dow for $20,000.
How is the Dow’s index value determined? Unlike most traditional indexes, such as the S&P 500, the Dow is not capitalization weighted. Instead, it is a price-weighted index, where a stock with a $100 price carries twice as much weight as one priced at $50. Back in 1896, when the Dow first started, the index value was easily computed by simply adding up the prices of each stock in the index, and then dividing the sum by the number of stocks. That, of course, is the mathematical formula for determining an average, and it is how that word came to be included in the index’s name. However, after years of stock splits, dividends, and constituent changes, the divisor had to be adjusted and is no longer simply the number of stocks. Today, the Dow divisor is 0.14602128057775.
You can’t buy the Dow, but you can approximate its performance by buying a single share of each of the 30 components, and that would cost you about $2,920 plus commissions. That should work for a while, but then you will need to determine how to handle dividends, splits, and changes to the companies in the index. However, there is an easier way. You can buy an ETF that tracks the Dow—it’s appropriately called the SPDR Dow Jones Industrial Average ETF (DIA), and it won’t cost you $20,000, or even $2,920. Instead, its current price is just shy of $200 per share, so each share represents about 1% of the Dow’s index value.
The Federal Reserve raised interest rates at the conclusion of its FOMC meeting today, and stocks moved higher after the announcement, pushing the Dow ever closer to 20,000. However, the rally didn’t last long, so we’ll have to wait a little longer to break the barrier. Keep in mind that the 30 stocks in the Dow trade somewhat independently of each other. Collectively, they determine the price of the Dow—not the other way around. Each stock does not know the price of the 29 others, and each is probably oblivious to the Dow divisor. Yet, all these seemingly unrelated things come together in the right mixture to produce the magical value of 20,000.
As suggested above, there is nothing magical about it. However, there is “importance” attached to the number. For the simple fact that it is a big, round number, it gets attention. Most importantly, it gets media attention. Media attention then generates trader and investor attention, and that can create market action. Although the index level of the Dow is somewhat arbitrary in the big picture, there is no denying it has a psychological effect.
The psychology of Dow 20,000 will have dissimilar effects on different people. To some, it will create fear or the desire to sell because it is too high. Others may feel like they missed the boat, prompting them to buy stocks in order to participate in future gains. For traders on the floor of the NYSE, it means a new hat. For me, this milestone will not directly cause me to take action on any of my holdings.
Disclosure: Author has no positions in any of the securities mentioned and no positions in any of the companies or ETF sponsors mentioned. No income, revenue, or other compensation (either directly or indirectly) is received from, or on behalf of, any of the companies or ETF sponsors mentioned.