If you watch coverage of the stock market, either via CNBC or the major networks, you will continually hear references to the Dow Jones Industrial Average. When people talk about the market being down, they will say something like this: “The Dow dropped 120 points today.”
What exactly does this mean, and how important is it to you as an individual investor? And who is this Dow guy?
A bit of history: more than 100 years ago, in 1882, Charles Dow, Edward Jones and a fella named Charles Bergstresser founded Dow Jones & Co. (I sort of feel sorry for Mr. Bergstresser, but let’s face it, Dow Jones & Bergstresser doesn’t exactly roll off one’s tongue, does it?) Although it started out as a growth index, it soon morphed into a transportation average.
The first Dow Jones Index included nine railroad stocks, a steamship line and a communications company. (How times have changed!) The Dow Jones Index was flexible and fluid enough to change with the times, and now the 30 companies making up the Dow Jones Industrial Average are large capitalization, well-known brand names selected by the editors of the Wall Street Journal. Over the years companies have been eliminated and added to ensure that the index stays current as a reflection of the broad U.S. economy. In fact, only General Electric remains of the original companies comprising the Dow Jones Industrial Average.
The stocks are weighted with a particular formula that you and I don’t particularly need to know. Despite many of its shortcomings as a reflection of the market as a whole (too narrow with the number of companies and stocks within the investing universe today), it is still one of the most watched indicators of the stock market’s health on any given day.
Now, if there are thousands of stocks to buy and sell in the trading world, an index of 30 of them isn’t going to be really accurate statistically, is it? (The answer is no.)
So along comes the Standard & Poor’s 500, which began in the 1920s but really took off in the ’50s …which none of you remember, right? The S&P 500 is an index comprised of 500 of the largest corporations (mostly American) in the stock world. Standard & Poor’s is a division of McGraw-Hill, the publishing giant, and they are responsible for maintaining the integrity of the S&P 500 index. Various industries are represented so that the S&P 500 is a fairly accurate assessment of the market as a whole, much more so than the Dow Jones Industrial Average.
There are some permutations of the S&P 500, such as the S&P 600 and the S&P 400, but the 500-count index is best known.
Doesn’t it make sense that the more stocks in your index measurement, the better the indications of how the stock market as a whole is doing? This is why, although the DJIA (Dow Jones Industrial Average) makes the headlines, many savvy investors pay no heed to its numbers but focus on the S&P 500 instead.
Okay, but we’re not done yet …
There’s the Russell 2000, an index that reflects 2,000 small-cap stocks. Kurt Russell? Jane? Jack? Where did the name come from? Actually, the Russell 2000 stock index came from the Russell Investment Group, a company offering investment services to its clients. They both sponsored and created this index, which began in 1936 as a subsidiary of Northwestern Mutual, headquartered in Tacoma, Washington. Naturally, the Russell 2000 is even broader-based than the S&P index, which would give you a very expansive view of the stock market’s performance.
But wait, there’s more! What if you wanted to have an index that comprised almost every single stock traded in the U.S. stock exchanges? Where would you go? Well, since 1974 we have the Wilshire 5000, which is often referred to as the Total Stock Market Index because it seeks to track the returns of practically all publicly traded U.S. companies. (There are actually more than 6000 companies in the Wilshire 5000, but who’s counting?) If you want to “play the market,” buy something that trades the Wilshire 5000 stocks and you will in essence own a piece of every U.S. company available to buy and sell.
What is the advantage of these indices? First, they give a quick, accurate picture of the stocks contained in each one. Secondly, for investors who don’t want to bother buying individual stocks but would like a “basket of stocks,” these are good for that kind of investing. You can buy them in ETF (Exchange Traded Funds) form, so that you pay only one commission to buy and one to sell, same as individual stocks. But remember that they will do no better or no worse than the indices they represent. There will be no surprises if you buy the S&P 500 and it goes up 8 percent for the year. Your portfolio encased in an S&P 500 ETF, will do exactly the same, no more, no less.
You now have more tools than you did before to be a savvy, secure investor! Happy investing!