Better information reaps dividends

When investors review the Dow Jones Industrial Average and other stock markets, they usually do not consider the changing value of a point.

People focus on the changing numbers in points, such as "the Dow is up 10 points," rather than looking at the changing value of a point, says Arthur Lupia, the Hal R. Varian Collegiate Professor of Political Science.

If news reports about a stock market included other meaningful information, such as its value in comparison to things that people buy (e.g., oil) or other ways that they can store their earnings (e.g., the currencies of other countries), people could make better investment decisions, he says.

"Small changes in the emphasis and content of stock market reports can lead people to pay more attention to the changing meaning of the Dow Jones Industrial Average points which can, in turn, improve their decisions," he says.

Lupia and his colleagues studied the diluted value of stock market reports. He presented the findings Aug. 31 at the American Political Science Association annual meeting in Chicago.

Lupia, who also is a research professor at the Institute for Social Research, says the value of a Dow Jones point has declined significantly in recent years, thus news reports of "record highs do not mean what they used to." As a result, some people might be surprised to learn how little their IRAs and 401(k)s are worth when they retire.

The researchers tested their theories in an experiment that allowed a person to purchase stock or to convert the money into Canadian currency then place it under his or her bed for a year.

In one demonstration that included dividends and other benefits of holding stocks, Lupia and colleagues showed that an investor who bought all of the stocks included in the Dow Jones on Jan. 2, 2001, and sold them on the record-high closing date of 2006 (Dec. 27), gained $3,377.34  or $2,870.74 after taxes.

If, however, the same investor simply converted the money to Canadian dollars on Jan. 2, 2001, and changed them back for U.S. dollars on Dec. 27, 2006, his or her post-tax gain would have been substantially greater ($3,074.64) than it would have been from participating in a "record-breaking" stock market.

When the researchers repeated this comparison for nearly 800,000 combinations of "cash in" and "cash out" dates between 2001-06, they found that after accounting for taxes, investors would have been better off exchanging their money for Canadian dollars than buying the components of the Dow Jones 97 percent of the time.

The reason for this surprising result is that the value of a point on the Dow Jones Industrial Index is tied to the value of a U.S. dollar, Lupia says. In recent years, due to a series of economic factors and political decisions, the value of the U.S. dollar has fallen substantially against other benchmarks, such as an ounce of gold, a barrel of oil, the Euro, and the Canadian dollar. The meaning of a Dow Jones point increase and record highs in the stock market are severely diluted, he says.

The changing role of the U.S. economy in the world should lead people to rethink generations-old assumptions about the U.S. dollar, as well as Dow Jones points, as a steady measure of value, Lupia says. He argues that small changes in how stock market information is reported can help people understand how the falling U.S. dollar affects the financial futures of people who invest in IRAs and 401(k)s. If news reports help people to understand this relationship, investors get a more accurate picture of their financial futures, he says.

Lupia's co-authors of the study are political science graduate students Cassandra Grafstrom, Yanna Krupnikov, Adam Seth Levine, William MacMillan and Erin McGovern.