Often quoted, but often misunderstood, the Dow Jones has been around over 100 years and is used as a gauge of the health of the overall stock market. But, is it the best representation?
Sharon Ko: We see and hear about it a lot, the Dow Jones Industrial Average. While your eyes may glaze over and it’s not something you necessarily understand or are interested in, but it does matter. Here’s a crash course on the Dow.
Karl Eggerss: So the Dow Jones is a stock index. So back in the late 1800s, I think 1896, Charles Dow, who it’s named after, he was trying to figure out a way to help people figure out how is the overall stock market doing. And so he put together 30 companies, called them the Dow Jones Industrial Average, and said these 30 companies are a good representation of the entire US economy at that time. And so he came up with a point system and said, we’re going to monitor this over time, and that tells you generally how the stock market’s doing.
Karl Eggerss: Now over the years, they’ve taken out companies, they’ve added. It’s a point system, so literally what they do is when you see a stock that’s trading at $100 per share or $50 per per share, each of those companies is given a certain number of points it contributes to the Dow Jones. The higher the price of the stock, the more points it gets in that index. So literally when you see 27,000, it’s an addition of all the points of only 30 companies. Since that time when it was created, over the last hundred years, there’s lots of, it’s called an index, there’s lots of indexes now, or indices. All of these are meant to give you an idea of how the overall stock market’s doing in any particular day, month or year. So if it says the Dow Jones is up 10% this year, that means on average maybe a lot of stocks are up about 10% this year.
Sharon Ko: How can 30 companies give an accurate, or I guess a great snapshot of the health of the economy?
Karl Eggerss: Well, it’s an excellent question and that’s why a lot of people don’t use the Dow Jones as a barometer anymore because it is only 30 companies. So they will use something, probably the one that’s more popular is the Standard & Poor’s 500. And if you look on the news every day, you’ll see the Dow Jones, you’ll see the Standard & Poor’s 500 and you’ll see the Nasdaq. They’re all three different indices, they have three different baskets of stocks in them, but to your point, 500 companies has got to be a better representation than 30. And it is, however, each of those indices are calculated differently.
Karl Eggerss: For example, the Standard & Poor’s 500 is calculated by the size of the company, not necessarily the share price. Whereas the Dow Jones, as I mentioned, it’s calculated purely off of the points or the price per share, and so two different methodologies. At the end of the day, they don’t vary too much at the end of the year. If you were to look, for example, from January 1st to December 31st, if the Dow Jones is up 25% you may see the Standard & Poor’s up 27 or 23. It’s going to be within the ballpark, but I think that’s a valid question. Why not use one that has more companies? There’s even one called the Wilshire 5,000, which is 5,000 companies. And so again, you can look at that and see what’s the overall stock market doing.
Sharon Ko: So at the end of the day, should the average person worry about the Dow and, for example, when it comes to their 401K?
Karl Eggerss: It’s a good gauge to see are you in the ballpark of what the market is doing. So, for example, if you had a whole portfolio of stocks and your portfolio was down 10%, and yet the Dow Jones was up 10% at the end of the year, you would say, “Well, why is that up 10% and I’m down 10%? Something may be owning the wrong stocks.” Now because it’s at 27,000, people ask all the time, “How much higher can this go?” And there is no limit. In fact, if it just continues on the trajectory it’s been on since 1896, it just continues that path, it would be at Dow 100,000 in just 23 years. And most people can’t fathom that, but remember the percentage it goes up right now, these are bigger numbers than they used to be. When the Dow was at a 100, if it doubled, it went to 200. Now if it doubles, it goes to 54,000. So someday, probably in our lifetimes, God willing, we will see Dow 100,000.