The post election stock market rally persisted throughout the month of November, culminating in a new milestone for the Dow Jones Industrial Average (DJIA): 30,000. While the Dow is the oldest of the major U.S. stock indexes, it is the least useful because it only captures 30 companies and the index itself is calculated in a screwy way.
The Dow is â€œprice-weighted,â€ meaning that each of the thirty companies contributes to the value of the index based on its stock price. So Dow component United Health Group, whose stock trades for about $350 per share, has 10 times the influence of Walgreens/Boots, which trades at about $35 per share. The more relevant stock indexes are the Standard&Poorâ€™s 500 or the Nasdaq composite, because both are â€œcap-weighted,â€ meaning the market capitalization (the price of the stock multiplied by the number of shares outstanding) of each component determines the impact on the bench mark.
Nit picking indexes aside, does a milestone really matter? I know that â€œitâ€™s just a number,â€ but those big, round numbers can act as psychological markers â€” on both the upside and the downside. Thatâ€™s why I encourage you to put away your rally caps and refocus your energy on your personal goals and objectives. My worry is that with indexes rising, some of you may be tempted to ratchet up the risk in your portfolios. Now more than ever, you need a systematic approach to your investing and a better way to make higher quality decisions.
I was reminded of why having a smart process is so important after I interviewed Annie Duke, author of the new book, â€œHow to Decide: Simple Tools for Making Better Choices.â€ Duke, a former professional poker player and academic, drills down to explain why we make poor decisions and how we can create and adhere to a better system to improve our choices.
According to Duke, we tend to conflate the decision making process and the outcome of that decision, due to a concept called â€œresulting.â€ Resulting leads one to believe that if you get a positive result, you made a good decision. We do this because judging outcomes is easier than analyzing the decision making process. I asked Duke to explain resulting using the current backdrop of the pandemic.
She started with a simple premise: Any time you gather with others, especially indoors and unmasked, there is some probability that you could get infected with the virus. If you do this a number of times and donâ€™t get sick, was it a good decision to assume the risk? Absolutely not. â€œYou can make horrible decisions and have a good outcome because the outcome is probabilistic,â€ says Duke. In fact, â€œthere are only two things that determine how your life turns out: luck and the quality of your decisions. You have control over only one of those two things.â€
Applying the concept to investing, consider this: If you pile into stocks only because markets are reaching new highs or you have a â€œgut-feelingâ€ that the rally will continue, thatâ€™s a bad decision regardless of whether markets keep rising or if they drop. Instead, a robust decision making process would include contemplating various outcomes and weighing how they might impact your overall financial plan.
Duke warns that without a smart process, the outcome of a decision can lead you â€œto overlook or distort information about the process, making your view of decision quality fit with outcome quality â€¦ When you make a decision, you can rarely guarantee a good outcome (or a bad one). Instead, the goal is to try to choose the option that will lead to the most favorable range of outcomes.â€
Jill Schlesinger, CFP, is a CBS News business analyst. A former options trader and CIO of an investment advisory firm, she welcomes comments and questions at firstname.lastname@example.org. Check her website at www.jillonmoney.com.