DJIA index changes and the need to diversify

Yesterday, the Dow Jones Industrial Average got a significant reshuffle in its index constituents, where old economy stocks like Exxonmobil and Pfizer have been removed from the index, and replaced with stocks like – a cloud services provider, and Honeywell International – an industrial conglomerate.
The last update to the index, which represents the 30 largest companies in the US, was in 2018.
Following Apple’s 4-for-1 stock split, which will see its price divided by 4, its ranking in the Dow will fall to somewhere in the middle since the Dow weights its constituents by price, rather than market cap like the S&P 500.
Although the DJIA is not as significant an index compared to the S&P 500, which many index funds are constructed upon, it still signals how investors can position to capture value upside when it comes to stock prices.

Changes to the index represent changing realities of the world

The economy has changed, and with COVID19 accelerating digital transformation, technology stocks will increasingly make up a greater proportion of the index as they gobble up profits.
Tech disruption will continue to be a key theme for the next several years, and companies that can benefit from rising cloud and AI adoption will continue to see tailwinds in their stock prices, although they have become relatively expensive right now.
For example, growth stocks out-performance, measured by the Russell 1000 Growth Index compared to value stocks, measured by the Russell 1000 Value Index is now close to ~40%.
This could be due to low interest rates, where growth companies have a long-tail of expected cash flows in the future, being key beneficiaries in this environment.

It also represents the need to diversify smartly

Many investors still keep their portfolios highly concentrated in a single stock, although the upside potential is much greater, I strongly discourage this.
The world constantly changes, and winners – especially in industries and countries that outperform the market – often rotate according to factors like where the economy is at, central bank policies, and valuations.
It’s difficult to constantly pick winners like Tesla and Zoom, although in hindsight it’s very easy to envision how much you would have made if you had bought them.
The key is not to capture as much upside, but also to limit your downsides while capturing upside.
It also applies in the Singapore context, where many retail investors still continue to plow their monies into individual stock names like Sembcorp Marine and Singapore Airlines despite their low prices.
Stop beating a dead horse.
You are betting on multiple factors including the market mispricing the risk of the stock, the faster-than-expected recovery of its fundamentals, and forgoing the opportunity of alternative investments.
Remember it’s not about whether you think the stock goes up, but what the market thinks. All these are highly speculative factors that don’t end up well for most investors if the market continues to have a negative sentiment on the stock.

Leave a Reply

You May Also Like
Read more

Why roboadvisors might be worth the fees

It's probably contrary to popular belief - but if you're like me and you want things to work seamlessly, easily and effortlessly, then sometimes paying a premium for a product or service that delivers just that - might be worth paying a little more for.
Read more

On financial minimalism

The idea of minimalistic finance is rather intriguing, and it's about creating a system about your finances that's simple, stress-free and helps you prioritise for your financial goals.
Read more

Let’s talk about bonds

I am going to admit that talking about bonds will be a dry and boring topic, because bonds generally do not give exciting returns, do not fluctuate as wildly as stocks, and give an extremely predictable and steady stream of income. Why then, do some people get so interested in bonds? Should they be an integral part of our portfolio? Read on to find out.