Why the Dow is the Kardashian of Stock Indices

The Dow Jones Industrial Average is famous for being famous. As one advisor noted in a recent blog post "the Dow is ingrained in our subconsciousness as the premier benchmark for US stocks, which doesn't make any sense if you understand how the index works."

The Dow is a venerable index, originally created in 1896. But its structure has a number of flaws.

The biggest problem is that the Dow's construction and performance is based upon price-weighting, instead of being weighted by market capitalization like most major indices (such as the S&P 500). "In a price-weighted stock index, each company's stock is weighted by its price per share, and the index is an average of the share price."[Investopedia]

This leads to counter-intuitive results -- a smaller company has a much greater impact on the Dow's returns than a larger company. For example, UnitedHealth Group (UNH) constitutes 9.04% of the Dow due to its recent share price of $478. Apple (AAPL), at a price of $172, had only a 3.25% weight.

By way of comparison, Apple comprises 7.06% of the S&P 500, while UnitedHealth Group is only 1.20% of the index. This makes sense as Apple is a significantly larger company. "Nothing justifies weighting stocks by their prices," argues Gus Sauter, former chief investment officer at Vanguard.

The Dow consists of only 30 stocks, which may or may not be representative of the larger U.S. stock market -- such companies as Amazon, Google (Alphabet), Facebook (Meta), and Berkshire Hathaway are not part of the index. There are no specific rules for inclusion. The Dow is determined by a committee of people that work for a company known as S&P Dow Jones Indices.

Even knowing all of this, habit will still lead us to ask: "How's the Dow doing?"

Words of Wisdom

A celebrity is a person who is known for his well-knownness.
-- Daniel Boorstin (Historian)