What Is the Dow Jones?
The Dow Jones Industrial Average (DJIA) is a stock index that tracks the share prices of 30 of the largest publicly-traded companies in the United States. The component companies, or constituents, represent most industries of the economy except for transportation and utilities.
Created in 1896 by Dow Jones & Co., the Dow is one of the oldest stock indexes in existence. Initially, the index consisted of just 12 companies, but in 1928 it began tracking 30 companies. The composition of the Dow does not change very frequently, but from time-to-time, the index is modified to reflect company-specific developments and shifts in a particular sector of the economy.
Today, the Dow is owned by S&P Dow Jones Indices LLC, a joint venture between S&P Global and the CME Group. The index uses a price-focused methodology to give a weighted measure to the stocks it tracks. As a result, the companies with the highest share prices have the greatest influence over the performance of the index.
How Is the Dow Jones Industrial Average Used?
There are three primary, interrelated uses of the Dow: market monitoring, performance benchmarking and index-linked investing. Below, we briefly explore each use of the Dow.
Market Monitoring
The most common use of the Dow is to monitor how the market is performing and to gauge economic sentiment. While the index only tracks 30 blue-chip stocks, those 30 companies can have a massive influence on the economy.
As a result, the Dow offers a fairly reliable measure of domestic stock market performance and economic sentiment. People and organizations all over the world rely on the Dow’s readings to get a quick indication of how things are going in the United States.
Performance Benchmarking
Beyond simply monitoring the stock market in a broad sense, many investors use the Dow to gauge the performance of specific investments. For example, an investor in an actively managed stock fund can utilize the Dow to evaluate whether the fund managers are performing well as compared to the broader market. A favorable performance compared to the broader market indicates good decision-making and timing, while less favorable performance could indicate suboptimal trading.
Index-linked Investing
The third application of the Dow, which could arguably be the most beneficial to your personal finances, is index-linked investing. Also known as passive investing, index-linked investing is a widely popular and low-cost way to replicate the returns of the Dow (or any other index) rather than trying to outperform it.
For this method, an investment fund is established with positions that mirror the Dow’s 30 constituents. Depending on how the various companies perform, the fund can be adjusted, which entails buying more stock of outperforming companies and selling the stock of underperforming companies.
The result is an investment return that matches the performance of the Dow, minus a modest management fee. This process is the essence of index investing — you get to have diversified exposure without the exorbitant costs and administrative complexities of an actively managed stock fund.
Best Dow Jones ETF
The list of basic DJIA investment funds is limited, but the list gets larger when you include funds that utilize leverage or include option-based strategies. However, these exotic funds do not truly represent the performance of the Dow.
For the purest, most economical exposure to the Dow, focus on the following two exchange-traded funds (ETFs):
- The SPDR Dow Jones Industrial Average ETF (DIA) is the most reliable way to replicate the performance of the Dow. Launched in 1998, it has historically exhibited minimal tracking error, while levying a nominal fee of 0.16% (which amounts to $1.60 per year for every $1,000 invested).
- The iShares Dow Jones U.S. ETF (IYY) is the second-best way to replicate the Dow. It seeks to track the performance of 95% of the stock market in the United States by focusing on large-cap and mid-cap companies. However, the inclusion of mid-cap companies invites some tracking error when compared to the Dow.
Dow Jones vs. Nasdaq vs. S&P 500 vs. Russell 1000
While it’s a widely monitored index, the Dow is not the only index that tracks large companies in the United States. Many more comprehensive indexes exist, including those outlined below.
- Nasdaq Composite Index:
- The Nasdaq Composite Index tracks the performance of over 2,500 technology-related companies listed on the Nasdaq Stock Market and utilizes a capitalization-weighted methodology. However, unlike the S&P 500 and Russell 1000 indexes, the Nasdaq Composite Index contains foreign companies.
- S&P 500 Index:
- The Standard & Poor’s 500 Index (S&P 500) tracks the performance of the 500 largest companies in the United States. Like the Nasdaq Composite Index, it utilizes a capitalization-weighted methodology to determine proportion sizes. As a result, the companies with the largest market capitalizations (share price times number of shares outstanding) have the greatest influence over the performance of the index.
- Russell 1000 Index:
- The Russell 1000 tracks the performance of the 1,000 largest companies in the United States. Like the S&P 500, it utilizes a capitalization-weighted methodology. However, given the more expansive focus of the Russell 1000, the average market capitalization of its constituents is notably smaller than that of the S&P 500.
Summarizing the Differences in Indexes
When evaluating large-cap stock market performance in the United States, most investors focus on the S&P 500 because the index offers the purest, most diversified view of the domestic large-cap space. The S&P 500 is often preferred over the other indexes for the reasons outlined below.
- The Russell 1000’s inclusion of mid-cap stocks takes away from its ability to provide a pure view of large-cap performance.
- The Nasdaq’s technology tilt and international exposure detracts from its ability to provide a broad-market view of domestic performance.
- The Dow’s limited number of constituents, coupled with its potentially misleading price-focused weighting scheme, takes away from its ability to provide an accurate view of broad-market domestic performance.
Despite the points above, when it comes to how investors feel about indexes, differences of opinion are common. Moreover, while the Dow may not be as comprehensive as the S&P 500, it has long proved to be a quick and accurate indication of stock market performance in the United States.
Dow Jones Historical Data
On April 11, 2022, the closing price of the Dow was 34,308.08 — 6.8% off its all-time high of 36,799.65, which was reached near the beginning of 2022.
According to data compiled by Guggenheim Investments, over the 125-year period beginning with the Dow’s inception and ending on December 31, 2021, the index has experienced an annualized, inflation-adjusted return of 6.7%. However, actual returns during this period have varied widely — rising rapidly during five distinct bull markets and going sidewise during four distinct bear markets.
