I guarantee the Dow Jones Industrial Average (the Dow) is going to hit 500000. I’m so confident, I’m willing to bet dinner at the takers’ choice of restaurants.
If financial advisors are not allowed to guarantee results, why am I ensuring such a high mark for the Dow? I’m trying to illustrate the game financial prognosticators play, climbing over each other’s backs to make ridiculous projections just to draw attention to themselves. Be cautious on them touting individual stocks. But like my Dow 500000, the forecasters always omit the missing element of – time.
So WHEN might the Dow will hit 500000[i]? The Motley Fool calculated the annual rate of return for the Dow over the past 50 years is 8.02%.[ii] To be conservative, let’s lower that estimate to a 7.2% annual return. That return also allows me to simplify my introduction to a magical financial formula.
The Rule of 72
I don’t know why the Rule of 72 works, but it does. The Rule of 72 allows you to divide your expected return into 72, and the result will tell you how many years it will take for your investment to double in value. Thus, my annual return of 7.2%, divided neatly into 72, tells us that it will take 10 years for an investment to double in value.[iii] Per the Rule, the Dow, currently at approximately 40000, would double to 80000 in ten years, 2035. Extrapolating the Rule, the Dow would double again 160000 by 2045, 320000 by 2055, and perhaps around 2060, you will owe me dinner. Mark your calendar.
Warning: no matter what, the path to 500000 will be lumpy. And of course I am assuming there will be no World War III, climate tragedies, or Covid ‘34.
The market’s performance last year
I used the Dow in the first part of this article because most readers are familiar with it. However, the way the Dow Jones Industrial Average is calculated,[iv] it makes it a less representative index compared to the Standard & Poor’s Index (S&P 500). Let’s switch to the S&P 500 for a moment.
The S&P 500 was up 24% in 2023 and 23.1% in 2024. That translates to a compounded return of 53% over the two-year period. Don’t extrapolate. Remember trees don’t grow to the sky.
Half of the S&P 500’s return last year (13.7% of 23.1%), was attributable to just seven stocks, aptly named the “Magnificent Seven” or the “Mag 7.” (Apple, Nvidia, Microsoft, Amazon, Alphabet (Google), Meta (Facebook), and Tesla. As a point of reference, the Dow was up only 12.8% (again, read my footnotes explaining that the Dow is calculated very differently).
Also, of interest to my fellow caffeine addicts, one of the highest returns last year was cocoa, up 178.2%. Painfully, that affects the price of chocolate. Another one of our essential food groups, coffee, was up 69.8%. Ouch, that hurts!
Are Animal Spirits rising?
In 1936, British economist John Maynard Keynes coined the term “animal spirits” to describe when investors let emotions override their analysis on investment decisions.
Animal Spirits are composed of three primary emotions that fuel a herd mentality, FOMO, “Greater Fool Theory,” and absolutism:
- FOMO: A “fear-of-missing-out” occurs when investors think, “Bitcoin is up 33% since Trump was elected. I missed out, but I’ll be damned if I am going to miss the next move to $150,000.
- Greater Fool Theory: Is the false confidence investors have that after they make an investment, there will always someone that will purchase it at a higher price from them— the “more foolish” person.
The best historical example of the animal spirits’ greater fool theory occurred with the Tulipmania bubble during the 17th century. Tulips were just starting to be imported to Europe from the Ottoman Empire. Europeans marveled at the newly imported flower, and it became an immediate status symbol. Dutch Investors started driving up contracts for future purchases of tulips to a price where the rarest version of tulips traded at six times the average worker’s annual salary. Tulipmania illustrates how herd mentality drives irrationality. Logic prevailed in 1637, when tulips collapsed to a realistic value that left many ruined investors in its wake.
Like our relationship with addictive foods (chocolate and coffee), investors’ addiction to adrenaline drove up the price of cryptocurrencies in 2024– the merits of which I am not going to debate here. But as a perspective on the viability of cryptocurrencies, investors plowed $564 million into a crypto called Fartcoin (not a typo). In fact, Fartcoin has a total value greater than 38% of the stocks listed on stock market exchanges. Luigicoin, named after the murderer, Luigi Mangione, not me, didn’t do as well. Still on recent days over $3 million in Luigicoin changed hands. Is there a similarity between the utility value of tulips and cryptocoins?
From Grant’s Interest Rate Observer January 17, 2025caption. Subscribe here: Grantspub.com
- Absolutism: Either from panic, or a greedy FOMO urge, too frequently investors make radical 100% changes to the direction of their portfolios. Sell it all or bet it all on a single investment (ie., Nvidia, Bitcoin, GameStop etc.) This robs the investor of the safety from diversifying their investments over time– averaging into a position (ie., “dollar cost averaging”) to prevent someone from investing on the eve of a calamitous event, think September 10, 2001.
If I haven’t scared you a little about the current investing euphoria, consider that the Financial Times recently reported that Warren Buffett had increased his cash holdings and short-term Treasury Bills to $325 billion, or 28% of his portfolio. Personally, I’m not confident to be on the opposite side of the Oracle of Omaha.
So, should you exit the market?
Now that you know the Dow is going to breach 500000, what should you do?
First, know that the trip to 500000 won’t be linear. Twenty-percent declines in the market are definitely coming. No one foresaw 9/11 or Covid 19. Few predicted the Financial Crisis of 2007-2008. By design, market air pockets can only happen when investors are all on one side of the boat assuming the same thing.
Let’s go back to today’s Dow at approximately 40000. You are anticipating that a long-awaited 20% market correction is overdue. A 20% decline would bring the Dow down to 32000. If you sell “absolutely” everything now, you could avoid that. But what if the market climbs 10% to 44000 first, and then it declines 20% (8,800 points) to 35200? By having exited today, you would have only saved 4,800 points or avoided only 12% loss (4,800/40000). But what if the Dow pulls off another 20% year to 48000 before losing 20%. In that scenario, you would have only avoided a 1,600 loss (1,600/40000) or a 4% loss. It’s really difficult to pinpoint the top.
Likewise, if you exited the market, it’s difficult to pinpoint when to get back in. Investors get greedy. Oh, the Dow just hit 34000. I think I’ll wait for it to hit 33000, then I’ll get back in. Then, when the Dow hits 33000, the investor recalibrates: Maybe I’ll wait until it drops to 32000. But then, OMG, the Federal Reserve just lowered interest rates, and the Dow shot up 2,500 points to 35500. Damn, I should have gotten back in earlier.
Like it’s extremely difficult to pinpoint the top, it’s equally hard to pinpoint the bottom. It requires perfect timing…. twice.
What to do in 2025
The best thing to do going forward is, diversify, tweak your portfolio, and avoid the exotic high-hidden-commission, overly complex investments that appear during down markets.
Diversify: Don’t be an absolutist with a concentrated position in your account. There’s a risk of greater potential loss that is triggered by a negative headline when you have 14% of your account concentrated in a single company, than if you have only 5%. Think of CrowdStrike’s July 19, 2024 update that shutdown Delta Airlines’ business.
Keep some investments in Treasuries like Warren Buffett. If you have, for instance, 30% of your portfolio in Treasuries, and the stock market corrects 20%, your account would only be down around 14% (70% x -20%). And you would have the “gunpowder” (liquid funds available) ready to shift funds into stocks now that they are cheaper.
Tweak your portfolio: If Nvidia has skyrocketed to over 10% of your portfolio, sell some shares and move the funds to Treasury Bills or other companies. If Nvidia continues to climb, you should be content that you still have a position in the company. If Nvidia sinks, you will be pleased you liquidated some of your shares. You can win either way. Tweaking your positions makes remaining in the market psychologically palatable.
Taxwise: fine-tuning your account is easier in an IRA, because there are no tax consequences. If the shares are held outside of an IRA, talk to your tax advisor first. Your capital gains tax might exceed the correction you are trying to avoid (and high-taxed California offers no capital gains break). Outside an IRA, you can still:
- Sell (“specifically identify”) the shares you purchased at the highest price, which will minimize your gain and taxes, or
- If you have the shares in both your IRA and your individual account, leave the shares in your individual account untouched, oversell the shares in your IRA to compensate, to right-size your overall investment portfolio.
Avoid exotic high-hidden-commission investments
When markets slide, all the alternative investment salespersons feed into your fear.:
Insurance salesperson: “You could have invested in our annuity, and you wouldn’t have suffered any market loss. We personally insure your principal (not government insurance), lock you into this investment for the rest of your life, take 6% of your money as a commission, and limit your upside potential to 2% per year. But we got a lot of bells and whistles designed to confuse you.”
Or,
Private Equity/Private Credit salesperson: “You can invest in our product where we leverage your funds to expose you to even more risk, we will be completely nontransparent about what you are invested in, we tie your funds up for 10+ years, we base our compensation on our total guess of how much your investment appreciated each year, and then if the investment generates a 10% return, we keep 40% of that.”
Don’t do it! K.I.S.S.- Keep it simple stupid. Just about all these alternative investments can be replicated in liquid companies that trade on stock exchanges or with Treasury Bills that do not even charge a commission. Don’t let the salespersons mambo-jumbo you into thinking they are smarter than you.
And let’s do dinner in 2060
Be patient, trust the U.S. economy, diversify, keep your emotions in check, and let’s coordinate a dinner date in 2060 to celebrate Dow 500000. Is April good for you? Easter falls on the 18th.
General Disclaimer and Release: Nothing contained herein constitutes tax, legal, insurance or investment advice, or the recommendation of or an offer to sell, or the solicitation of an offer to buy or invest in any investment products, vehicle service, or instrument. Information here may include statements concerning financial market trends and/or individual stocks, and are based on current market conditions, which will fluctuate and may be superseded by subsequent market events or other reasons. Historical trends are not a reliable indicator of actual future market behavior or future performance of any particular investment which may differ materially and should not be relied upon as such. The investment strategy and broad themes discussed herein may be inappropriate for investors depending on their specific investment objectives and financial situation. Information contained in the material obtained from sources believe to be reliable but not guaranteed. Past performance is not a guarantee of future results. All investments involve a degree of risk of loss. Consult your financial advisor and tax advisor before implementing any of the themes discussed here.
[i] The Dow does not use commas and because of the way the average is calculated, it is considered an inferior measure compared to the Standard & Poor’s 500. The Dow does include commas when it refers to changes. For instance, the Dow was up 1,642 points over such and such a period.
[ii] That is a simple return, not the compounded return. And more trivia, the Dow does not factor in dividends when it reports the index’s price.
[iii] It also works if you need to double your investment within a certain period. If you need to double your money in 6 years (72 divided by 6 yrs), you will need to generate an annual return of 12%.
[iv] The Dow Jones Industrial Average gives more weight to stocks with greater share prices. Thus, a 5% move in Goldman Sachs, at approximately $600/share, has a greater effect on the Dow, than a 10% move in Coca Cola at $60/share.