More than half of all Americans have money in the stock market, much of it invested in funds through retirement accounts.
If you’ve been thinking about joining them in a more active way, you’ve probably run into a lot of information that makes the prospect seem daunting. Beginning investors can get overwhelmed trying to understand the difference between an NFT and an EFT or finding a good Dow Jones definition.
It’s good to take time to understand what you’re investing in, and one of the oldest stock indexes out there is a good place to start your investing journey. Let’s break down the Dow Jones and how it relates to investing in the stock market.
What Is the Dow Jones Definition
Dow Jones & Company was founded in 1882 by three financiers. They later created and published The Wall Street Journal, and by 1896, Charles Dow had developed the Dow Jones Industrial Average.
Dow had a knack for explaining complicated financial news and thought it would help investors to have a simple benchmark to help them quickly see if the market as a whole was going up or down. He also hoped to come up with a way to predict market movements based on the price activity of a group of stocks.
He started with an index averaging prices of transportation stocks, then created the DJIA with stocks from 12 mostly industrial companies. The index was later updated to include 20, then the 30 used today. When Dow first began, the index used the simple math of averaging to get a number investors could track and understand.
How the DJIA Works Today
Today, you’ll hear the index referred to as “the Dow” rather than the full name. In many ways, it’s the same basic DJIA Dow came up with and is now one of the most-watched indexes in the world thanks to the current company mix.
The index includes 30 companies — all big blue-chip stocks like Apple, Coca-Cola, Chevron, Walmart, Walt Disney, and McDonald’s. Those chosen are considered to be leaders in the economy and must be listed on the Nasdaq or NYSE.
While it still has the word “industrial” in the name, the list has stocks from most industries these days, except for utilities and transportation, which are tracked in other indexes. The list changes along with the economy and as companies become more or less important in their sector.
Calculating the DJIA
The index today is more than the simple average Dow used when he first created it.
It’s now a price-weighted index, which means stocks with higher share prices carry greater weight than those with lower prices. This allows the average to reflect the relative importance of each stock based on how much of the index’s total value it represents.
The prices of the 30 stocks are added together and divided by the Dow Divisor. That number changes along with the stock prices and counteracts changes that can skew the average like stock splits.
Value of the DJIA
The Dow is one of three indexes used to measure the performance of the stock market. The other two are the Nasdaq Composite, which tracks almost every stock on that exchange, and the S&P 500, which includes 500 large-cap stocks using objective criteria.
The S&P offers a broader view of the US economy than the Dow in part because of the larger list, but also because the Dow companies earn so much money abroad. The S&P and the Nasdaq are market capitalization-weighted, which means the most valuable companies have the most influence on the index value. That makes them more accurate measures of the stock market.
The Dow and the S&P tend to perform close to the same, while the Nasdaq is far more heavily weighted with tech sector stocks that don’t always follow the market as a whole.
Investing in the DJIA
If investing in the Dow sounds appealing, there are a few ways you can go about it. You can’t buy shares in the DJIA, but you can get shares in a mutual fund that tracks the index. That fund buys into all 30 stocks in proportion to how they’re weighted in the index.
You could also buy shares in each of the companies on the list. However, this isn’t always practical as you would need to keep up with the index to know what to own. Plus, since these stocks are big household names, their individual share prices often reflect big single share prices.
Following an index helps you create an instant diversified portfolio, and in the case of the Dow, exposure to major companies with successful track records. Because you buy into a fund, you can start with far less money than it would cost to invest in each company individually.
That said, the Dow is pretty narrow for an index fund with just one class of stock — big blue-chip. You might miss out on areas in the market with the most potential for growth.
Looking for the Right Place to Invest?
Now that you have a better grasp on a Dow Jones definition and the stock index tied to it, you might wonder if it’s the right place for you to invest. While it doesn’t represent new-market or fast-growing opportunities, it is full of the kinds of blue-chip stocks that can make for solid, long-term investments. A fund tracked to the index makes it simple for investors to get a diversified portfolio.
Need some help finding the right place to put your investment capital? Contact Bogart Wealth to discuss a plan for your wealth management needs.