The big headline the other day was news of the Dow Jones Industrial Average (DJIA) reaching 20,000 for the first time. It’s gathered headlines all over the world. I counted 13 articles in The Wall Street Journal about the Dow 20,000. Most of the mainstream media has been quick to jump on what this means for investors, the market, and the future. And some of that thinking is flawed. This post will focus on putting this milestone in perspective for you and, more importantly, what it means for your investments.
The Dow Jones Industrial Average is probably the most iconic index. When someone says the market is up 150 points, they are referring to the DJIA. It has a long track record – about 130 years! So on the surface this milestone is impressive. It took the Dow over 100 years to reach 10,000. It took 18 years for it to reach 20,000. But it took only 42 days to go from 19,000 to 20,000. That’s the second fastest thousand point gain in history. So what does that mean for you? To answer that, we need to pull pack the curtain to understand what is the Dow Jones Industrial Average:
- It is an index consisting of 30 companies. That’s a very small representation of the overall market and can completely misrepresent how the whole market is doing in reality.
- The Dow Jones is 100% US stocks which represent a single asset class. On top of that, it skews heavily toward large-cap industrial companies. This may have been valuable 130 years ago when the index was first created, but the economy has changed drastically since this index was first created. No longer are industrial companies an accurate representation of the overall market like they once were.
- A company is included in the DJIA because it was selected by a committee of the Wall Street Journal. They actively decide which companies should be included and which should be removed.
- The common methodology to determine the weighting of each company is very unusual. Most modern indexes are weighted based on the market capitalization – the bigger the company, the larger representation it holds in the index. The DJIA weights the company based on the share price of each stock. The larger the price per share, the larger the weight in the index. That puts Goldman Sachs as the largest holding at about 8% and GE at the second lowest (about 1%). This reason for this methodology dates back to a time before computers when a simple methodology was needed.
- Here is a technical issue – the DJIA was prone to inaccurate calculations before computers were used to track the index. In going back to the very beginning and correcting all the mistakes, the DJIA passed 30,000 last month.
- While you can’t invest directly in indexes, you can invest in indexes the mimic and replicate the performance of the underlying index. When you total the dollar amount that tracks the DJIA, it adds up to about $36 billion. To put that in perspective – over $2 trillion track some version of the S&P 500!
As you can see, this is a deeply flawed and outdated index. It serves very little use for most investors because of these flaws. It is not a good gauge of the overall health of the market or the economy. It barely does a good job of capturing the health of industrial segment of our economy in the US. It should never compared to a broad, diversified investment portfolio. So the Dow reaching 20,000 is a big story about an out-of-date index.