Keeping Up With the Dow Joneses
As many of you know, on March 5th it was announced that Apple was being added to the Dow Jones Industrial Average, replacing AT&T, effective on the open of trading March 19th. Since this has been a topic of curiosity for many of our clients, I thought it would be a good idea to talk about the Dow Jones Industrial Average on this edition of Short Squeeze.
The Dow Jones Industrial Average was first calculated by Charles Dow in 1896 using twelve industrial stocks. Today’s Dow is a price-weighted average of 30 actively traded blue-chip stocks. For indexes of US stocks, price weighting is unique to the Dow index. The way price weighting works is that each stock influences the index in proportion to its price per share. Therefore, a stock trading at a higher price per share, such as Apple, will have a larger impact on the movements of the Dow versus a stock trading at a lower price such as Cisco or GE.
Given that the Dow is so narrow in scope (30 stocks) and is calculated using price weighting, most of the professional investing community no longer use the Dow as their primary benchmark for overall market performance on any given day. Most money managers (including mutual funds and hedge funds) benchmark their performance against the broader S&P 500 Index or the Wilshire 5000 Total Market Index. These indexes track 500 and 5000 stocks respectively, and therefore give a much better picture of overall market performance.
However, the Dow is a darling of the media and is always the index you hear reported on the nightly news. We’ve been conditioned to feel anxiety anytime the Dow is down triple digits. For example, on April 2nd the opening price of the Dow was 17699.52. If we experienced a one-day 120 point drop in the Dow, that would equate to a loss of 0.68%. In a stock market valued in the trillions of dollars, a pullback of 0.68% should hardly be reason to fret. However, if you turn on CNBC or Fox Business, some pundit will be on TV explaining why “we’re down triple digits on the Dow.” By comparison, based on the opening price on April 2nd (2060.03), a one-day 120 point drop in the S&P 500 would equate to a pullback of 5.83%. Now THAT would be something to worry about!
Until next time.
—Brett C. Hixon, CFP®
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