When scanning the market for a top exchange-traded fund (ETF) to buy for the new year, choosing a beaten-down sector or theme is usually a great bet.
In 2022, the consumer discretionary sector, tech, and communications suffered steep sell-offs. And with so many quality names in those sectors, they were good picks for 2023.
But investors looking for value and income might find the market's high valuation of many growth-orientated sectors off-putting.
The more I look at the SPDR Dow Jones Industrial Average ETF Trust (DIA 0.36%), the more it stands out as a balanced way to gain exposure to various industries and top companies. Here's why investing in the Dow Jones Industrial Average could work out well in 2024.
Image source: Getty Images.
The Dow's known flaw is overplayed
The long-standing criticism of the Dow is that it is price-weighted. This means that the rather arbitrary price of a stock dictates its weight in the index, rather than the case with a market-cap-weighted index like the S&P 500 and the Nasdaq Composite, where Apple and Microsoft hold the highest weightings since they are the most valuable companies.
The price-weighted system isn't perfect. But it works itself out, as the Dow is much more balanced than it is often given credit for. The stocks that do well over time (assuming no stock split) hold a larger share of the index, while the ones that languish hold a smaller share.
The big exception is Apple, which would have been the largest stock in the Dow if it hadn't issued a stock split in 2020. But overall, the system works well.
About half the stocks in the Dow have between a 2% and 5% weighting. Six stocks have over a 5% weighting, and six stocks have below a 1% weighting. The stocks that are heavier weighted are probably the ones that most investors would rather have more of.
The six stocks with a weighting over 5% are UnitedHealth, Goldman Sachs Group, Microsoft, Home Depot, McDonald's, and Caterpillar -- all quality, dividend-paying companies with low to medium growth prospects.
The Dow has a unique blend of different industries, whereas the S&P 500, and especially the Nasdaq, are dominated by tech, consumer discretionary, and communications. Here's a look at the Dow's breakdown by sector compared to the S&P 500
|
Sector |
SPDR Dow ETF |
Vanguard S&P 500 ETF (VOO 1.00%) |
|---|---|---|
|
Financials |
20.8% |
12.9% |
|
Information technology |
19.3% |
29.1% |
|
Health care |
18.7% |
12.7% |
|
Industrials |
15.2% |
8.3% |
|
Consumer discretionary |
13.4% |
10.7% |
|
Consumer staples |
6.8% |
6.3% |
|
Energy |
2.7% |
4.1% |
|
Communication services |
2.3% |
8.6% |
|
Materials |
1% |
2.5% |
Data sources: State Street Global Advisors, Vanguard.
The Dow is much more focused on sectors with value and income than the S&P 500. But it is still packed with plenty of growth, with over 30% of the index allocated to tech and consumer discretionary stocks.
The Dow's concentration is an advantage
The big difference between the Dow and the S&P 500 or Nasdaq 100 is that the Dow has only 30 stocks. So there are just a handful of companies representing a sector.
You can think of the Dow like a representative democracy, where there is an elected official that represents a much larger sector, whereas the S&P 500 is going to include several stocks from a sector, and a total market fund will include hundreds.
In this vein, the Dow is basically a concentrated portfolio with only the industry-leading companies. And with a few exceptions, I think the Dow stocks are great choices.
The Dow stocks I'm not particularly a fan of are IBM, Cisco Systems, Verizon Communications, Merck, and Walgreens Boots Alliance. But these stocks make up just 6.7% of the Dow. All of them have underperformed the market in recent years. And because of that, they are gradually making up a smaller share of the Dow.
Here's where the beauty of the Dow really starts to shine. An outperforming stock, no matter the sector, has the potential to contribute to big gains for the index. It happened with UnitedHealth, which has outperformed the S&P 500 over the last five years and is now the highest-weighted stock in the Dow. Microsoft had a big year in 2023, and it could one day surpass UnitedHealth as the most important stock in the index.
In sum, the composition of the Dow lets winners run by giving them a larger share of the index. It achieves sector diversification. And it has plenty of industry-leading growth stocks, value stocks, and income stocks.
The Dow is a perfect fit for conservative investors
Before buying a Dow ETF, I think it's important to first and foremost generally agree with the Dow's picks.
If you'd rather see Morgan Stanley in the Dow instead of Goldman Sachs, Bank of America instead of JPMorgan Chase, and Mastercard instead of Visa, well, that's a problem because financials make up over 20% of the Dow. Barring any major disagreements, the next question would be if the Dow fits your investment objectives.
The biggest downside of the index is that it leaves very little room for explosive growth. Massive industry-leading companies can only move so much compared to smaller companies.
Rather, the Dow is more about low risk and moderate potential reward, which could benefit investors who are risk-averse, focused on capital preservation, or simply looking to take their foot off the gas and deploy new capital toward less risky avenues in 2024.
No one knows if the Dow will beat the S&P 500 or the Nasdaq in 2024. But we know that the index tends to outperform during a bear market and stands a good chance of limiting the downside risk that can come with investing too heavily in unproven pockets of the market.
