Recently, I was reading a great article at The 99 Percent entitled The 40-30-30 Rule: Why Risk Is Worth It. I originally intended to include it in my weekly roundup, but as I thought about the 40-30-30 idea, I found that the connections to careers, personal finance, and life were profound.

What is the 40-30-30 rule? Simply put, it’s an argument that when you prepare for anything in life, only 40% of the preparation is physical – the rest is mental. Thirty percent of preparation is technical skill and experience, and the second thirty percent is the willingness to take risks.

This “rule” comes up again and again in all different areas of life. Here are several examples from my own life where I’ve seen it.

When I’m playing a game I’ve played a lot of times before, I have an intuition as to what move to make next, built from years and years of experience (the 30% that comes from technical skill and experience). However, I also find that it’s very easy to just keep using the same strategy over and over again because I’ve somehow come to the conclusion that it’s the best one. So, if I combine that technical skill and experience with a risky new strategy I’ve devised (the other 30%), I might lose – but I might also devise a way of playing that’s even better.

With investing, I have a good understanding of my own risk tolerance, an understanding built up over a long period of time (the 30% that comes from experience). Howver, I also know that if I don’t push against my risk tolerance a bit and look at new investment opportunities from time to time (the other 30%, risk), I’ll likely miss out on great opportunities.

I also see it in my career, both now and when I worked for a large organization. I would often have a well-worn daily routine that worked and got the things done that I needed to get done (the 30% that comes from experience), but if I really want to excel, I sometimes have to step outside the box a little (the risk-based 30%).

The 40/30/30 rule really does provide a great framework for success, no matter what you do.

Do something worthwhile (the first 40%) means that you’re willing to get up off the couch and do something. Maybe it’s getting ahead in a career. Maybe it’s getting into a new hobby. Maybe it’s simply getting a grip on your investments. 40% of the journey is simply trying.

Keep at it (the next 30%) is simply encouragement to not let a new initiative slide, because the more you work at it, the easier it becomes. Even more important, the more you work at it, the more the basic skills that make up the task begin to become natural to you.

Take risks (the final 30%) simply means to not do things the same way every single time. When you’ve become skilled at something, it’s easy to become wedded to the same routine. Never stop looking at what you do and trying out alternate paths. Not only does this grow your skills (making your basic routine even better), it also helps you to uncover new ways of doing things.

Great… so how do you do this? How can you apply the 40/30/30 rule in your life? The best first step is to figure out the area of your life where you want to improve. Do you want to get out of debt? Do you want to improve your skill at a musical instrument? Do you want to get a promotion at work? Do you want to become a writer?

Once you’ve figured out what you want to do, research it a bit. Figure out what things you’ll need to do to accomplish that goal.

After that, start practicing and building skills. The best way to do that is to start doing the thing you want to master every single day. For me, a thirty day project works well for this. I just commit to doing a certain thing every single day for thirty days (if that’s possible). At the end of it, I’ve usually vastly improved at whatever skill or attribute I was trying to develop.

Quite often, thirty days is enough to establish a positive new routine in your life, so keep it up. Keep doing that thing every day until it becomes truly normal and seemingly effortless.

Then, take a risk. Change what you’re doing a bit. Make it more difficult, or at least different. Explore something new. If you’re taking a walk every day, increase your walking pace a bit and use a stopwatch to slowly trim your time around the block. If you’re trying to break through at work, volunteer for a task that you might have avoided before, like giving a presentation. If you’re playing a game, try a completely different strategy and see how it works. If you’re investing, dig into some new investments that you haven’t looked at before and consider putting some money into them after you’ve studied them.

What you’ll find is that your already-built skill will help carry you through this new challenge and that the rewards of this new risk are great. You end up in better shape, with a better career, with a better gaming experience, and with better investments – or with improvement in anything you’d like to take on in life.

Whenever a personal finance writer – or a writer of any kind – wants to make a bold, shocking point, they’ll often pull out an “average” of some set of numbers. That average, when read without further investigation, is often really shocking. Could that really be true? Here are some examples.

The average square footage of single-family homes under construction fell dramatically, from 2,629 in the second quarter to 2,343 in the fourth quarter. (from USA Today)

The average credit card debt per household — regardless of whether they have a credit card or not — was $8,329 at the end of 2008. (CreditCards.com statistics)

The average 401(k) fell 27% in 2008. (MSN MoneyCentral)

Those numbers seem fantastic. I grew up in a home that had about 800 square feet and currently live in a home that feels huge to me at times and is just shy of 2,000 square feet. The average home has over $8,000 in credit card debt? That’s well over $100 a month just in interest!

However, if you start teasing those numbers apart a little, a few interesting truths reveal themselves.

Let’s look at the first one. The average new home has 2,343 square feet in floor space. Well, let’s assume that one in five homes is a 7,000 square foot McMansion. That means that four out of five newly built homes are just 1,200 square feet. In other words, if you lined up all of the houses that were built in the last year side by side ranked by their size and chose the one in the middle, it would be far less than 2,400 square feet.

How about the average credit card debt? Again, the huge ones skew the average. If you have three homes with no credit card debt, one with $10,000 in credit card debt, and one with $30,000 in credit card debt, the average credit card debt of those homes is $8,000 even though three out of five of the homes have no debt at all. The facts back this up – the majority of American homes carry no credit card debt.

That third one is also interesting. The average 401(k) fell 27% in 2008, yet the stock market (as judged by the S&P 500) dropped 37%. What does that mean? Lots of investors out there didn’t have all of their eggs in the stock market basket.

Whenever you hear a news report or read an article where someone quotes an average, you should get your guard up because there’s a solid chance that a skewed story is being presented.

How is it skewed? Quite often, when we hear “average,” we compare our situation to that number. Yet, as we’ve seen above, the vast majority of people are often well under (or in some cases over) that average. That average is misleading, and if we compare our own situation to that average and use it as guidance for moving forward, we can often mislead ourselves.

How can you figure out the real story? One big first step is to look at the exceptional people on either end. Take the house square footage example. The biggest houses built would be over 10,000 feet, while the smallest ones would be around 1,000 square feet. Then, look at the average. The end that the average is closest to is where most of the people actually are. After all, if there are 9 people building 1,000 square foot homes and 1 person building an 11,000 square foot home, the average is a 2,000 square foot home – but none of them are actually building a 2,000 square foot home.

Good luck.

Andre writes in:

I’m interested in replacing a piece of home audio equipment that is experiencing occasional malfunctions, but works OK most of the time. The receiver I’m looking at costs $500 on Amazon. I’m a little conflicted. The more frugal side of me says to not even buy it. Make do with the broken receiver until it’s completely unusable. The less frugal side says to save up for it and buy a new one. That sounds perfectly logical and responsible. Save for a few months, instead of putting it on my credit card. The receiver I’m looking at is highly-rated and is considered a great buy for the price, according to CNet. I’ve done research and think this is a good value for what I’m getting, compared to other similar items. I feel like I’ve done everything right but still feel a little guilty in thinking of buying it.

This is one of the biggest challenges for a frugal person. When is it appropriate to just “make do” with what we have on hand, and when should we bite the bullet and buy a replacement? And when we do, is it appropriate to buy a high-end replacement, or should we just go for the best bang for the buck every time?

I think both questions come down to the same key factor: how truly important is this item to your quality of life?

Let’s look at Andre’s case. Let’s say Andre is a serious audiophile. Every evening when he comes home from work, he puts on a series of jazz albums that play all evening at his house while he reads, works on personal projects, and does housework. Perhaps Andre is even a musician himself. The music is one of his biggest passions in life – he can’t imagine an evening without that soundtrack to his life playing.

If that’s the case, Andre should maintain his home audio equipment. He should save up for that replacement component and he should buy a high-quality one that meets his needs.

On the other hand, let’s say Andre listens to his audio system once a week at most. He turns it on when there are guests over and perhaps he’ll turn it on on a lazy Saturday afternoon, but other than that, it sits there silent. He enjoys music, but it’s not his life’s passion.

If that’s the case for Andre, he should make do with what he has and, when it breaks, get a “bang for the buck” replacement for it.

I think this is largely true for everything in life. All of us have a few key central passions. Once you know what those passions are, it’s completely fine to spend a little more on it, provided you can afford it and can save for it.

The problem with overspending comes in when we begin to overspend on areas that are less important to us. For example, if Andre wasn’t passionate about music but he still convinced himself to drop hundreds/thousands of dollars on his home audio system, that’s probably a misuse of money. If he’s not deeply in love with the driving experience, dropping thousands extra on a luxury car probably isn’t a good use of money.

I’ll use myself as an example. I’m passionate about cooking at home. A big part of that for me is getting great, fresh ingredients. Thus, I’m willing to spend quite a bit more to get great ingredients. I don’t feel bad when I spend $30 on cheeses or I buy organic fresh produce or when I replace the old casserole I had in college with a top-notch French oven.

On the other hand, I don’t value having a perfect living room set. I’m more interested in something that’s simply comfortable. So I don’t go out and spend a ton of money replacing our living room set all of the time. It’s just not something I value beyond the minimum function of it.

In the end, I have about three or four key passions in my life that I don’t feel bad spending money on if I can afford it easily. Outside of those passions, I’m as tight as a drum.

Andre, the answer to this question really comes from you. How much do you value the audio listening experience? Is it something that’s central in your life, or is it just something on the periphery? That alone will provide the guidance you need.

A post on a “savings generation gap” at Get Rich Slowly the other day caught my eye. In it, J.D. argued that there’s a “generation gap” between spenders and savers. People who are over some particular age threshold – somewhere around 35 or 40 – tend to save their money, whereas people who are younger than that tend to spend their money.

I agree with J.D.’s general conclusion that there is some sort of gap between spenders and savers, but I think the age thing is merely incidental. In my eyes, the real difference between spenders and savers is that the savers realize that they have something to lose.

In my own life, I was a big spender during my early professional years. I lived in an apartment with my wife and, in essence, had very little to be responsible for outside of my job and my marriage. I worked hard at both of those, but in terms of worrying about taking care of the future, there really wasn’t much to take care of. I didn’t have a house. I didn’t have dependents. I wasn’t established in the community yet – most of my friends were holdovers from college who were similarly unanchored. I had lots of free time.

Roll the clock forward several years. At that point, we’re living in a house. We have two children. I’m involved in several community projects and serve on multiple boards. We have lots of friends and acquaintances in our town, too.

Before, I didn’t really have too much that I could lose. If I spent all my money, there really wasn’t any risk involved with it. As long as I kept up with my career, I could live through my money mistakes. I felt very free to spend with reckless abandon because there was little real-world consequence to spending in that way.

Today, if I spent like that, there would be serious consequences. Would we be able to keep our home? Would we have to leave the community we’ve worked hard to establish ourselves in? What about our children? Am I doing what I can to take care of them? As I write this, I’m sitting in a home that’s a huge six-figure investment of our money – I need to make sure it’s not falling apart, either. The income from my writing career is notoriously unstable, too.

I save because I now have things in my life that I need to protect. That wasn’t true earlier in my life.

I think the idea that “saving is for old people” comes from the journey that people take in life. Early on, we have fewer elements in our life that we need to protect. We don’t have a home. We often don’t have a marriage. We often don’t have children. We often don’t have an established role in the community. We often don’t have an established career.

Later on, many people do establish these things. They begin to realize that they can indeed lose their life’s work. They want to protect all the work that they’ve done. So they begin to save. Often, this is coupled with other shifts in life perspective as well.

In that context, there is something of a correlation between age and saving tendencies, because older people have more to protect and are more aware that it needs to be protected. Older people have the fruits of many years of labor, something that younger people simply have not had the time to bring to harvest yet.

Of course, looking back on my journey, I regret not saving during my early years. Most of the things I spent money on then have left me with nothing at all now except for a worse position in life. Spending so freely for so long directly means more worries today – a result that I could have easily prevented by looking with even the slightest critical eye at my purchasing choices.

Did I need to learn that lesson? I don’t know. I think that some people need to learn it. I think that others have it ingrained in them from an early age.

The holiday gift-giving season is upon us once again. For many of us, that means stress. What gift can we give to the people we care about that actually means something? Why do the holidays have to be so expensive after we buy gifts for everyone on our Christmas list? Then, on Christmas Day, we have to find polite things to say about the unwanted gifts we get and we find ourselves with a bunch of additional stuff to take care of whether we like it or not.

All of these problems can be solved by one simple change in your perspective about gift-giving this year: give experiences instead of things.

What do I mean by this? Instead of giving a material gift that would require you to spend money on something you’re unsure they’ll like and them receiving something that they’ll have to now take responsiblity for, give them something that isn’t material.

Six Ideas for “Experience” Gifts
Here are six quick ideas to get you started, but there are hundreds more just like it if you let your creativity go.

For a child, give a field trip. This could be a trip to a zoo, to a kid-friendly science center (like the wonderful one in Des Moines, Iowa), a wilderness hike, or to a baseball game. You’ll handle all the logistics of the trip for them.

For a food lover, offer a home-cooked version of a meal they’ve longed for. Try making them something challenging like coq au vin or beef bourguignon. Get out your fine china and linens for this dinner, too – make it something special. It could be a romantic gift for a food-loving couple.

For an art lover, plan a trip with them to the art museum of their choice later in the year. Buy the ticket and handle the transportation yourself.

For a spouse, pledge to do the dishes for a year – or give them a few weekends where they can do whatever they want (with or without you).

For a gamer, give them some invitations that allow them to choose a game to play with you. This is a great way to understand someone’s hobby better (and perhaps find it interesting and exciting yourself).

For a parent, give a free night of babysitting. To them, this means an evening doing whatever they’d most enjoy doing without having to worry at all about their children.

Barter for Services
If you have some good ideas for experiences but don’t have the cash, look into a barter with the person that could provide that service. For example, you might be willing to work 40 hours at a museum or a zoo for a certain number of tickets. Perhaps you could provide IT services at a spa in exchange for some gift certificates there. Many businesses are quite willing to offer credit in exchange for your skills and/or your time. Take advantage of that.

The Presentation
Many people balk at such gifts because they’re unsure how to present it. With a home printer and some time, you can create an elegant presentation of any gift.

First, spend a little on a decent stationery set that you can use for many such gifts over the long haul. Look for something tasteful and simple that doesn’t necessarily have to be holiday-oriented.

Second, use a straightforward layout in your word processing program of choice. There are thousands of templates for Word, most of which are compatible with most word processing programs out there.

Fill out the document with the details of the gift, print it on the best printer you have access to, and also print the envelope with the recipient’s name on it in an elegant font.

Here’s the kicker: include some visuals within the envelope. A brochure that shows what the event is all about is perfect, as is a photograph that provides a visual reminder of what you’re going to do. It can even be something as interesting as snapshots from a past event you’ve enjoyed together.

Why This Works
Aside from the fact that it’s less expensive than giving traditional material gifts, giving experiences works for three reasons.

First, it doesn’t give a material item that the other person will have to deal with. It’s not going to wind up needing maintenance or taking up storage space in their home or requiring a trip to customer service.

Second, it will stand out in a positive way in comparison to the items they receive. When you receive several items for Christmas, something distinct like this will definitely stand out from the crowd. Most of the “experience” gifts I’ve ever received still stand out for me.

Third, it often allows you to experience the gift together. If the gift is an event you can both participate in, it becomes a shared memory, something far beyond what a material gift can offer.

For us, unfortunately, “experience” gifts are a bit of a challenge since we don’t live near many of the people we exchange gifts with. Of course, we have another solution for many of those folks for frugal, unique Christmas gifts… but that will have to wait until next week.

Over the last month, I’ve mentioned a technique I call “the five whys” two or three times. The technique itself is simple: when you see something in your life that’s not working like you want it to, you start asking “why” until you come to something where you can’t say “why” any more. When you find it, you’ve diagnosed the core problem – and, quite often, the solution to that problem is surprisingly simple.

Three Examples
In order to illustrate this, I thought I’d use three real examples from my own life recently, as I’ve been using “the five whys” more and more lately to uncover the roots of some of the problems in my life.

Example 1: Crunching the Numbers
I usually calculate my net worth in a spreadsheet because I like the layout and the reports, but I don’t update it as often as I might like.

Why? It takes quite a lot of time to dig out all of those numbers.

Why? They’re stored in a lot of different databases and on a lot of different websites, which I have to visit individually to extract the numbers.

As a result, I’ve decided to give Quicken a shot again. In the past, I used Microsoft Money for about a year until I found that I didn’t like the reports it generated – I preferred what I had in my own spreadsheet. Quicken may be able to provide better reports (it looks like it will from the reviews I’ve read) and, even if it doesn’t, it’ll make it easier to retrieve the numbers I want to see. (And, yes, I’ll be posting a review of it in the near future.)

Example 2: Broken Exercise Routine
During the final push to complete my book, I abandoned my regular daily exercise routine because I needed absolutely every spare minute. Since I finished it, I’ve been having difficulty getting back into that exercise routine.

Why? Every morning, I feel fairly pressured to write content for The Simple Dollar instead of exercising.

Why? I have (post-book) writer’s block and my usual protection against it (unpublished posts that I have in reserve) isn’t there any more, because I used many of those in the final push to finish the book and the few days afterward when I simply needed to do something besides write.

Why? I’m lacking the “idea juice” I usually have and without it, my entire daily routine is disrupted.

So, my solution is to find ways to reinvigorate my creativity. Over the last few days, I’ve been spending time on brainstorming exercises, simple writing exercises, and so on, as well as just reading a lot – all of that while avoiding the keyboard. It’s really starting to help. Then, as I get back in the flow, I’ll be able to build up a backlog of articles again, enabling me to feel free to exercise in the mornings.

Example 3: Laundry Backup
We often wind up with a large backup of laundry, then find ourselves doing several loads on a single weekend day.

Why? Our laundry routine doesn’t work.

Why? One big problem is that our laundry room is literally as far as possible in our home from our bedrooms, plus the laundry room is back in the corner near the guest bedroom. Out of sight, out of mind. As a result, we often don’t even think about the laundry until the evening, when we’re just about ready for bed. Then, in the morning rush, we walk right by it.

Why? It’s more convenient to just ignore it in the morning and we’re too tired to deal with it in the evening.

A solution presents itself. Fill up a laundry basket in our bedroom in the evening and place it right in front of the door so that we’ll trip over it in the morning if we don’t deal with it. Then, when we go downstairs in the morning, we carry the basket down and we’re pretty much ready to drop in a load of laundry on our way out the door. I’ve started doing this and it actually really works.

Why It Works: The Path of Least Resistance
In the normal routine of our lives, we almost constantly take the path of least resistance when it comes to choosing what to do. What’s the path of least resistance to get from where we are now to where we want to be? We do this over and over and over again.

The only problem is that when we choose this “path of least resistance,” we often aren’t choosing the best path. If only we would choose to take some extra effort right now to remove some of that resistance, we might find a much more effective path to get where we want to go.

For example, the “path of least resistance” for me to figure out my finances was to use a spreadsheet because Microsoft Money didn’t do what I wanted. Of course, as I found out, the spreadsheet itself had significant resistance, so now I’m trying to use Quicken along with my spreadsheet (and maybe not even with my spreadsheet) to reduce that resistance, making the whole thing much more usable.

Another example: the “path of least resistance” for doing laundry was to just let it build up then do a bunch at once. The only problem was that we essentially would devote an entire day to laundry (usually Saturday was laundry day). I can reduce that big resistance by just filling up a basket before bed (a tiny resistance) and then carrying it down in the morning (another tiny resistance).

When you do the “five whys,” you’ll eventually find your way to the resistances in your life that are keeping you from what you want to be doing. When you dig into those resistances and find ways to break them, you make it much easier to go down the path you want to go down.

Why do you spend so much money each month? You might dig down and find that certain places tempt you, so just by avoiding them, you don’t spend as much. You might find that certain friends convince you to spend more, so focus on spending more time with your other friends.

Why aren’t you succeeding at work? You might dig down and find that it’s because you’re afraid to volunteer for projects, so you might overcome that by simply resolving to take the plunge on the next project that comes through. You might find that the politics of your workplace encourage you to avoid stepping up or that the entire company is poisoned, which might indicate it’s time to move on in your career.

You can use “the five whys” in every aspect of your life. If you spend some time thinking through the problems in your life in this way, you’ll almost always dig down from something that seems insurmountable to something that you can fix. That fix might lead to the big change you want or it might not, but no matter what, it’ll almost always change the dynamics of your life for the better.

I like keeping score.

Keeping score is an easy way for me to know how well I’m doing. It lets me judge, in a very clear way, whether I’m improving and whether I’m making forward progress towards my goals.

For a long time, I was obsessed with keeping score in various aspects of my life against other people. I’d keep score with the various gadgets we had. I’d keep score with who had the best trading card collections. I’d keep score with who had the best-stocked liquor cabinet.

What I found, though, is that keeping score against other people in such ways left me feeling empty. Every day – every hour, even – there was another way to keep score against someone else, and I could never win all the battles or even most of them. Even worse, when I would lay my head on my pillow at night, it was just me. There was no one to keep score against, and even if I had a higher “score” in some aspect of life than others, most of the time I was left unfulfilled by that.

Over time, I began to find a lot of power in keeping my own score.

Net Worth
The primary way I “keep my own score” is by calculating my net worth quite frequently. I use my net worth as a score to judge whether or not I’m making successful, smart moves towards improving my personal finance state. I “win” if my net worth goes up. I “win big” if my net worth goes up by some specific amount each month.

Calculating your net worth is quite easy. Simply make a list of all of your debts and another list of all of your assets. Add up your assets, add up your debts, then subtract your debts from your assets. The resulting number is your net worth.

I calculate my net worth each month. I use a simple spreadsheet to do this – here’s how you can build one exactly like it.

Using Net Worth to “Keep Score”
Each month, when I calculate my net worth, I “keep score” in three different ways.

First, I compare my net worth to the previous month’s net worth. Obviously, I strive to have this go up each month, but during months where there are car repairs and other issues, it doesn’t. If I don’t see a decent increase from month to month – and having calculated this many times, I know what to expect – I’ll start digging for “why” this didn’t happen in order to improve my game.

Second, I compare my net worth to my net worth one year ago. This must be an increase – and hopefully, a sizeable one. I do this mostly to help me realize how far I’ve come over the past year, as it’s often an amazing reminder (particularly when compared to annual income) how our hard work is paying off.

Third, I look at the goals I set at the end of last month. Each month, I set goals for the coming month. Usually, these are “thirty day projects” of some kind, where I’m trying to teach myself a new normal behavior or two. One month, it might be minimizing our grocery bills to teach myself how to get the nutritious foods we need for less. Another month, I might go without spending a single dollar on entertainment. At the end of the month, I’ll reflect on how the goal went and see how it impacted my net worth – it’s usually a positive impact. Even better, I’ve usually picked up a good behavior or two by doing things this way.

Obviously, I also set goals for the next month. I usually pick a “target number” to shoot for – think of it as trying to beat one’s high score at an arcade game. I also usually define a “thirty day project” of some sort – sometimes two – to help me master a good behavior or two that will reflect well on my financial state.

During the month, if I feel like I’m on the verge of making mistakes, I’ll often calculate my net worth just as a quick reminder. It’s much like playing a game and glancing up at the score at the top of the screen – a quick reminder of how well you’re doing and a bit of a push to keep up the good work.

In a nutshell, keeping score is a key part of how I keep my personal finance in balance. It keeps me motivated and focused without causing me to “compete” in areas that are detrimental to my overall goals (like getting into “gadget wars” with friends).

Mickey writes in:

In the last week, the Dow Jones Industrial average closed at a thirteen month high and, at the same time, unemployment hit double digits for the first time since the early eighties. I thought that the Dow Jones was supposed to represent how the economy was doing, but that’s not the case. What does it mean? What is the point of reporting it if it doesn’t mean anything?

The Dow Jones Industrial Average (often called “the Dow” for short) is an incredibly common piece of news, yet the purpose of it is often really unclear to newswatchers. Is it an indication of the state of the economy? Not really. Is it an indication of the state of the stock market? Not really.

Well, then, what is it? And why does it get reported so often?

What Is the Dow?
The “Dow” usually refers to the Dow Jones Industrial Average. It was invented by Charles Dow, a co-founder of Dow Jones & Company, which is a publishing and information company.

The “Dow” is simply an average of the value of one share each of thirty of the largest companies in the United States. It does not include any of the thousands of other publicly traded companies.

Of course, a bit of math checking would reveal that if you added up the current market value of a share of each of the thirty companies in the Dow and divided by thirty, you would not get a number anywhere close to the current value of the Dow. There are several reasons for this, but the most important reason is that companies sometimes choose to split their stocks, basically exchanging two new shares for one old share (or some similar exchange). In order to make sure that such an exchange doesn’t wreck the value of the Dow (because that would effectively mean one of the thirty companies just had a single share of their stock drop by half), Dow Jones & Company accounts for it by using a scaled average, in which they effectively keep track of past splits and multiply the values of each share accordingly. Thus, even when a company splits their stock, it doesn’t affect the Dow average at all.

So, basically, the Dow is just a quick summary of the current value of shares of thirty large companies.

The Value of a Share
But what is the current value of a share?

In simplest terms, it’s all about supply and demand, just like buying and selling anything. The stock market is basically no different than a giant flea market, with many, many people buying and selling thousands of items, all trying to make a profit. Depending on the news (and the behavior of others), the price of individual items goes up and down.

In simplest terms, if there are more people buying than selling, the price of a share goes up. If there are more people selling than buying, the price of a share goes down.

What causes this shift? Information about a given company or about the economy in general. Predictions about what the future holds. The behaviors of others. All of these affect whether people are buying at the moment or selling at the moment.

The Value of the Dow
In effect, the Dow is just an average of thirty items from this giant flea market. What information can we get from that?

Generally, it’s not ruled by news from one specific company. One company’s bad news can affect it a little, but not enough to make a huge difference.

It’s also not affected too much by how things are going right now. It’s important to remember that when people buy and sell stocks, they’re doing it based on what they think the future price holds. Thus, the value of the Dow will often go down well before real economic news (like the unemployment rate) turns bad, and the value of the Dow will often go up well before real economic news turns good.

To put it simply, at the first sign the economy is slowing at all – or that one sector is seeing real problems – the Dow will begin to drop, and often rapidly. At the first sign that a recession is slowing even a bit, the Dow will begin to go up, and often rapidly (and that’s what’s happening right now).

So, look at the Dow as a predictor, nothing more, nothing less. It’s a predictor of the general direction of the economy over the next year or so. If the stock market is going up – as it is right now – the economy will generally improve from its current state over the next year.