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Why the Dow Jones Industrial Average Is Pointless

Investors and media still follow the Dow Jones. But a look at the index's mechanics shows there's little reason to do so.

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Indeed, the fact that the dominant retailer in the U.S. — a company that quite literally is reshaping the consumer landscape in this country — isn’t included shows the limitations of the Dow Jones Industrial Average. It is supposed to be a index that represents the U.S. economy, yet it doesn’t include what seems like the most innovative, disruptive company in that economy.

So why is the Dow Jones still used? Inertia is probably the most logical reason. The simplicity of the index and even its name lends itself to quick media soundbites. “The Dow closed down 80 points today” appears an easy way to describe the market’s action.

But easy isn’t accurate, particularly in this case.

The nature of the index lent itself well to market coverage decades ago. Changes in a 30-stock, price-weighted index could be calculated with pen, paper and a calculator (with the latter tool optional). But in the computer age, when second-by-second updates are available worldwide, for free, the insistence on following the Dow makes little sense.

The S&P 500 has the limitation of focusing almost solely on large-cap stocks, but it at least accounts for ~80% of total U.S. market value by most estimates. The Wilshire 5000 covers almost the entire U.S. market. The Russell 2000 gives a glimpse into the movement of small-cap stocks. And the Nasdaq-100 — which does include AMZN, FB, and GOOG — is a useful shorthand for understanding the market’s sentiment toward tech.

There’s another thing those indices all have in common: they are weighted by market cap, not by price. In other words, they cover more stocks in a far more accurate manner.

So if you’re wondering whether the Dow will hit 20,000, save the time. There are many more useful indices out there.

As of this writing, Vince Martin did not hold a position in any of the aforementioned securities.


Article printed from InvestorPlace Media, http://investorplace.com/2017/01/dow-jones-industrial-average-pointless/.

©2017 InvestorPlace Media, LLC