Today the Dow Jones
Industrial average pushed passed 20,000 points, a new milestone. What does this mean and should you care?
The Dow is a stock market
index collection of 30 large American companies. The Dow was founded in 1896 by the Wall
Street Journal editor Charles Dow. The
Dow’s market value is created by adding up the share price of those 30
companies and dividing them by a random number called the Dow Divisor. These are 30 random companies that the Dow
has put together, and these companies aren’t necessarily the largest companies
either. Google, for instance, isn’t a
part of the Dow.
Interestingly, the 30
companies that make up the Dow are not always the same and regularly get
replaced. As this
article by the Conservative Income Investor explains, the stocks the Dow
Jones committee chooses to make up the index can have a huge effect on the
returns calculated by the index. In
March 1939, the Dow committee decided to remove IBM from the index and replace
it with AT&T. Later in 1979, IBM
re-entered the Dow Jones Index, replacing Chrysler. From 1939 to 1979, IBM ended up being the
best performing stock in the US stock exchange.
Amazingly, $1000 of IBM stock in 1939 would end up becoming $41 million
in 1979! If the Dow had kept IBM in the
index, it would have pushed pas 20,000 in 1975, and not 2017!
While the Dow IS an
economic indicator, it’s a pretty crappy one.
It only tracks 30 companies, and these 30 companies don’t represent the
entire US stock market properly. If you
really want to get an idea of how the stock market is doing, a better metric to
follow would be the S&P 500, which is made up of 500 American companies. The Wilshire 5000 index tracks 5,000 of the
largest American companies and is another good metric to follow. This being said, financial pundits still
can’t stop hyping the Dow as a market index.
The only thing going for
the Dow as an index is that it has a very long 120-year history. I personally think that pundits refer to it
because it is attached to a nice BIG number.
When you hear that the S&P 500 closed at 2,298 today, it just
doesn’t sound as exciting as hearing that the Dow closed at 20,068 today. Bigger numbers make bigger financial
headlines. Financial news makes a 100-point
drop in the Dow sound scary, but it is really just a 0.5% change.
Planet Money podcast did
a great episode on why the Dow is a terrible measure of the US economy. You can hear the short and entertaining
17-minute podcast here.
While the Dow hit new
highs today, so did the S&P 500. And
this suggests that investors see the economy improving. New jobs are being added, unemployment is low,
and consumers are confident. Many
investors believe that this could be a start of even greater stock market
returns. Other investors believe that these
market highs won’t last long and that a crash is coming.
What should you do? Ignore the hype and stay the course. Keep saving, keep investing, and keep pushing
closer towards your own financial freedom.
