The stock market is one of the oldest institutions in America, dating back to the 1790s with the initiation of the Buttonwood Agreement. The buying and selling of shares of exchanges like the New York Stock Exchange created ways for private citizens to earn wealth while public companies raised funds. But for the first century of trading stocks were measured individually by price and market cap, and no real barometer of the overall market existed.
That changed with the creation of the Dow Jones Industrial Average, a stock index that combined 30 of the largest public companies in America to form a cumulative measure of US markets. The Dow Jones Industrial Average remains one of the most important stock indices today, although its makeup has changed greatly over the decades.
Many investors point to the Dow Jones Industrial Average as the first stock index. But that title actually belongs to the Dow Jones Transportation Average, which predated the Industrial Average by 12 years. The Dow Jones Industrial Average wasn’t created until 1896, when Wall Street Journal editor Charles Dow devised a new stock index composed of the 12 largest industrial companies in the US.
Today, the index has expanded to 30 companies, although none of the original 12 components remain. While the Dow has far fewer stocks than the larger S&P 500 index, it’s still used as a barometer for the US stock market since it no longer contains strictly industrial stocks. Some of the largest banks and entertainment companies in the country now reside inside the Dow.
In the beginning, names like US Steel, Chicago Gas Company, United States Leather, General Electric, and American Tobacco dominated the index. None of these original components remain (the last being General Electric, which got the boot in 2018). Today, while industrials like MMM, Honeywell, and Dow Inc. still make up a large chunk of the index, the components are more diverse across industries. Some of the latest additions include:
- Nike Inc (shoes and apparel, added 2013)
- Goldman Sachs (financial services, added 2015)
- Walgreens Boots Alliance (retail, added 2018)
- Salesforce (information tech, added 2020)
- Amgen (biotechnology, added 2020)
The Dow Jones Industrial Average is a price-weighted index, which means the stock price of the 30 companies is combined and then divided by a specific number (known as the Dow Divisor, which currently sits at 0.152). The divisor is altered whenever stock splits occur amongst components so that the split doesn’t affect the price of the overall average. Selection occurs via committee, although there’s no firm set of rules for inclusion.
Many mutual funds and exchange-traded funds track the Dow Jones Industrial Average and you can fund offerings from major fund providers like Vanguard, Fidelity, and Charles Schwab. As always, fees matter more than past performance when selecting index funds, so don’t overpay for basic securities.
While the Dow Jones and S&P 500 are often quoted interchangeably as barometers for the US stock market, the process used in the formulation is quite different. For starters, the Dow contains a mere 30 stocks compared to the 505 stocks that make up the S&P 500. More isn’t always better when it comes to investing, but some key American companies like Amazon, Google, and Facebook are left out of the Dow. Tech is overly represented in the NASDAQ 100 index, but quite underrepresented in the Dow.
Another difference between the Dow and S&P 500 is the calculation used to reach their total. As mentioned above, the Dow is a price-weighted index, with the prices in the individual stocks combined and then divided by the Dow Divisor. The S&P 500 is a market cap weighted index, with the components given standing in the index based on their total market capitalization (stock price multiplied by outstanding shares). Market cap weighting is usually considered a better way to gauge a company since stock prices can fluctuate wildly. A high stock price doesn’t necessarily mean a large company – market cap is a better way of determining a company’s true size.
Regardless of which index you prefer, both do a fairly decent job of measuring the overall output of the US stock market. In the last 30 years, returns for the Dow Jones Industrial Average and S&P 500 Index have been nearly identical. So ignore those who tell you the Dow is outdated. It may not have the best representation of the US economy, but it’s an important gauge when tracking the overall health of the stock market.
The opinions voiced are for general information only and are not intended to provide specific advice or recommendations for any individual.
Stock investing includes risks, including fluctuating prices and loss of principal.
Investing in mutual funds involves rick, including possible loss of principal. Fund value will fluctuate with market conditions and it may not achieve its investment objective.
ETFs trade like stocks are subject to investment risk, fluctuate in market value, and may trade at prices above or below the ETF’s net asset value (NAV). Upon redemption, the value or fund shares may be worth more or less than their original cost. ETFs carry additional risks such as not being diversified, possible trading halts, and index tracking errors.
No strategy assures success or protects against loss.