Just the Basics: Market Indices

The financial world is constantly comparing investments to indices as performance benchmarks. How do market indices differ, and what is their relative importance? Here’s a brief primer.

Dow Jones Industrial Average

Investors are sometimes surprised to learn that the much-quoted Dow Jones Industrial Average (DJIA) consists of the stock value of just 30 U.S. companies. After all, “the market is up today” is a phrase that tends to be accepted as an indication of the entire economy, not just the weighted average of 30 stocks.

The Dow is the oldest, best-known and most referenced financial index in the world. Its member companies are selected by the editors of The Wall Street Journal, and they change with the times. In February 2008, Bank of America and Chevron replaced Altria and Honeywell. And two more points:

• The DJIA is calculated by adding together the current prices of its 30 stocks, then dividing the total by the periodically modified “Dow divisor” (which as of February 19 was 0.12283402).
• Because it is made up of some of the best-known U.S. companies, large swings in the Dow tend to correspond to the movement of the entire market.

S&P 500

In 1941 Standard Statistics merged with Poor's Publishing to form Standard & Poor’s, the company that produces one of the most respected benchmarks of the overall U.S. stock market.

The S&P 500 index consists of 500 stocks chosen for market size, liquidity and industry group representation. It is:

• Compared to the Dow, much more representative of the U.S. market; and
• Market-value weighted, meaning that each stock's weight in the index is proportionate to its market value.

Dow Jones Wilshire 5000

Despite its name, this index includes more than 7,000 tradable securities (there were only about 5,000 when Wilshire Associates created it in 1975). It is:

• Inclusive of the New York and American stock exchanges as well as active over-the-counter equity issues, and
• One of the broadest indexes to track overall market performance.

NASDAQ Composite Index

NASDAQ is the acronym for National Association of Securities Dealers Automated Quotation System. It is an electronic stock market, with computer systems facilitating trading and providing price quotations on more than 3,000 actively traded over-the-counter stocks. There is no trading floor. No longer a haven only for obscure companies, among its members are Amazon.com, Inc., Staples, Inc. and Microsoft Corp. The index is calculated on a market-capitalization-weighted basis, which means that stocks with a larger market capitalization have a greater influence on how it performs than stocks with a smaller market capitalization.

Lack of Portability Dogs Foreign Retirement Plans

The lack of portability between U.S. and foreign retirement plans isn’t a problem for most, but for people caught up in them, it can be an annoying, if not costly matter.

One-Way Flow

Many countries offer retirement plans similar to U.S. individual retirement arrangements, and many give those plans portability. If you’re an Australian citizen and have an Australian tax-advantaged superannuation plan, Australia may allow you to roll the funds in that plan into a similar plan in the United States. Australia is willing, but the United States is not. It may seem confusing to the holders, especially in cases where familiar U.S. mutual fund names are involved – several offer plans in other countries. Just switch your money into a U.S.-equivalent plan, eh? The answer is “No.”

Various other countries, no matter whether their retirement funds are in registered retirement savings plans (RRSPs) or registered retirement income funds (RRIFs) in Canada, superannuation plans (Australia, New Zealand), pension schemes (United Kingdom) or personal retirement savings accounts (Ireland), offer portability under certain circumstances. However, it takes two to make an exchange, and the bottom line is that there simply isn’t any portability to an IRA or qualified plan on the U.S. end.

Canadian Dynamics

Probably the most tested taxability and portability issues arise between Canada and the United States. If a Canadian works in Detroit, he or she may well have the option to participate in an employer sponsored U.S. 401(k) plan or another qualified plan offered by the U.S. employer. Under current Canadian law, it is possible for those funds to be transferred to a special RRSP that exists outside the usual contribution limits.

A U.S. citizen who is a resident of Canada and eligible for an RRSP, RRIF or other Canadian retirement plan may defer U.S. income tax on accrued income within the plan until it is distributed. However, funds in such plans cannot be transferred to a U.S.-based IRA.

International retirement plan matters can be very complex. If this is an issue that concerns you, please call me.

Financial Planning:
Retiring Soon? Have You Saved Enough for Healthcare?

People who believe they have saved enough to retire sometimes fail to calculate their likely future healthcare costs -a rapidly increasing number, according to new research.

A study released in February by the Center for Retirement Research at Boston College suggested a couple needs to set aside $206,000 for medical costs as they begin retirement at 65 (an individual would need $102,000). A different study, conducted for Fidelity Investments, puts the figure at $225,000 for a couple retiring this year, up 4.7% from the $215,000 estimated for 2007. These figures have risen rapidly – at an annual rate of 5.8% – since the first Fidelity study in 2002 found that a couple would need $160,000.

After examining the current levels of retirement savings, the Boston College center said six out of 10 older wage earners are at risk of not being able to maintain their retirement standards of living because of the costs of healthcare. Retirement planning experts agree that saving for healthcare should be a central element in anyone’s retirement savings plan.

Steadily rising costs include higher charges for a doctor’s visit, use of new technologies and the generally rising incidence of chronic conditions, such as diabetes.