A Stock, An Index, and a Twinkie

“Even if parallel lines do meet and I see it myself, I shall see it and say that they’ve met, but I still won’t accept it.” Ivan, The Brothers Karamazov, Dostoyevsky, 1879.

“There must certainly be a vast fund of stupidity in human nature, else men would not be caught as they are, a thousand times over, by the same snare.” Cato, as quoted in Seeking Wisdom, Bevelin

When I was young, I had no idea what the stock market was. But I knew it was important. When my Grandfather repaired his car—-standing in a white muscle T-shirt, khaki pants, and Mexican huaraches—-he’d listen to AM radio, which gave regular market updates.

“The Dow Jones Industrial Average is ….”

He’d tilt his head and listen. I was maybe five or six. I looked up to my Grandfather, literally. He was over six feet, lean, with white hair and a white mustache. He had a high school education but was ferociously independent, both in his reading and habits. If he cared about the Dow Jones Industrial Average, it must be important, I figured.

But who was Dow Jones, what was industrial, and what on earth was an average? I’m embarrassed to admit that it took me years to learn the answers to these questions. No one in my house had any idea how the stock market worked. So, today, a sketch of how I think of the stock market and a case study on the difference between investing in an index versus a stock.

1. Charles Dow and Eduard Jones were, like a lot of us, trying to come up with a way to simplify a complex reality. In 1882 they used the concept of an “average” of the price of the top industrial companies that could boil the performance of the stock market down to a single number. Thus, the DJIA.
2. Since that time, all manner of people have come up with “indexes” and now many people save their wealth in such vehicles, like the S&P 500 index or the Nikkei or FTSE.
3. An index is a pile of stuff. The S&P is an index of the 500 largest and most liquid companies in the US, ditto the indexes for other countries. Indexes are helpful in that they do indeed simplify reality but they are terrible in that, as an investor, you really don’t know what you are buying. It is like the ingredients on a Twinkie … ferrous sulfate, thiamine mononitrate, riboflavin, tallow. What is this stuff?
4. Today, as I wrote earlier this year, the S&P 500’s 16% year-to-date gains are concentrated in a few companies that have massive market capitalization and have gone up in value this year because investors are willing to pay more for the same amount of earnings.

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