When people talk about how “the market” is doing, they’re usually referring to the Dow Jones Industrial Average (DJIA).
The DJIA is a benchmark group of stocks (a “market index”) that’s maintained and reviewed by editors of The Wall Street Journal. It consists of 30 American companies that are considered blue-chip industry stalwarts, household names with long track records of success and stability — like Wal-Mart, Coca-Cola, IBM, and Procter & Gamble. (Click here for the full list of Dow Jones stocks.)
The numerical value of the DJIA — the number you see on the stock charts — is just the price-weighted average of these companies’ stock prices.
The calculation uses the “Dow divisor,” a numerical value that’s constantly modified to adjust for things like stock splits and dividends.
What is the DJIA used for?
Along with the S&P 500 and the NASDAQ, the DJIA is one of the oldest and most widely used market indexes in the world. Investors use it to get a sense of how the overall market is performing and how their personal portfolio is faring in comparison — AKA whether or not it’s “beating the market.”
Many investors choose to invest passively alongside the Dow by investing in index funds and exchange-traded funds (ETFs), which mimic the performance of specific market indexes. You can’t beat the market with these investments, but you’re guaranteed to match it. (Check out some of the advantages of index investing here.)
Is the DJIA an accurate representation of the market?
It depends who you’re asking.
Some believe the DJIA gives a very accurate picture of the market because it represents a huge swath of the U.S. economy — its component companies are all top dogs in today’s leading industries. So even though there are thousands of publicly traded companies, DJIA advocates think that these big boys are large enough to act as a proxy for all the other businesses.
Critics, however, argue otherwise. Why? For one, the DJIA isn’t very diverse — it’s restricted to just 30 U.S. companies. Secondly, it’s price-weighted, meaning that stocks with a higher price will have a greater influence on the performance of the index. Many people criticize this system because it fails to account for a company’s actual size in the market — a company with a high stock price but a relatively low market cap will have an outsized impact on the DJIA.
The Foolish take
There’s not a “right” and “wrong” when it comes to market indexes — no single index can be all things to all people. But whenever you invest in an index or just use one to assess the performance of your own portfolio, it’s important to familiarize yourself with its strengths, weaknesses, and what exactly it measures.
If you want to learn more about some of the major market indexes, head over to our Index Center, or check out Fool Jay Jenkins’ article on the differences between the Dow, NASDAQ, and S&P 500. Ready to try your hand at index investing? Read over our 60-second guides on index mutual funds and ETFs to get started.