Tune in to any news channel on TV or pick up any newspaper and the one U.S. stock market benchmark that you will inevitably find reported is the Dow. Yet the Dow – more formally called the Dow-Jones Industrial Average (DJIA) – is not especially representative of the broad stock market. Or for that matter even of just industrial stocks. So why has the Dow become so ubiquitous?

The answer might be that the Dow is simply one of the oldest indices. It was created by Dow Jones & Co. co-founder Charles Dow in 1896. That’s a pretty long-lived track record. Unfortunately, it’s hard to use the Dow to measure long-term stock market performance for several reasons:

• The 30 stocks comprising the Dow are too few to be a representative sample out of about 3000 publicly-traded U.S. companies. In fact, the index didn’t even start with thirty stocks.  The original one comprised only twelve. It wasn’t until 1928 that it grew to its current size.
• The composition of the DJIA is constantly changing. With different companies moving in and out of the index over time, it lacks the consistency to use as a gauge of performance over its history.
• The timing and criteria for inclusion and removal – which is managed by a selection committee at Standard & Poor Dow Jones Indices – is not publicly disclosed to my knowledge. And when it is announced that a stock is being removed due to poor performance, as was done in 2018 to the last remaining company since index inception (General Electric), it subjects the index to survivorship bias.

As if that weren’t enough, there’s a bigger problem with the Dow, and that is how it’s calculated. It is the only commonly-utilized index that is price-weighted. That means stocks with higher prices have a bigger impact on the overall index average that the cheaper companies do. I can think of no rational reason for this approach other than possibly the ease of calculation when it was created back in the pre-computer age.

The S&P 500, created in 1957 as an alternative index, is a market capitalization-weighted index, meaning the weighting of the funds in the index is based on the stock price times the number of shares outstanding. This is logically a better measure of value. And with 500 stocks in that index, it is certainly more representative of the broader market. The S&P 500 also utilizes objective criteria by which a company can join or exit the index.

There are other indices that could rightly claim to be more representative because they include even more stocks. The Russell 3000, for example, comprises the top 3,000 stocks and represents 98% of all the publicly-traded companies in the U.S. The Wilshire 5000 incorporates the market value of every actively traded American stock. As of 2023 that was a little over 3,400 companies. There are also the CRSP U.S. Total Market Index and the Dow Jones U.S. Total Stock Market Index, to name a few more. All these indices are market cap-weighted, even (interestingly enough) the Dow total market one.

I first wrote about this back in 2017, yet the media has still not seen fit to respond and elevate some other U.S. stock market benchmark to the top of the heap. But at the end of the day, it really doesn’t matter. You can’t use any single benchmark to compare how well a diversified investment portfolio is performing. What’s more important is whether or not your investments are growing sufficiently to support what you want to do for the rest of your life. That requires you to come up with an investment strategy that balances the risk and return needed to meet your future goals. Forget about the Dow.

(Source: Wikipedia).

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