A few weeks ago, The Dow Jones Industrial Average, the oldest most widely known stock index in the US, broke 20,000 for the first time ever. While this may seem impressive, the Dow’s relevance today is actually quite small given:
1) The DJIA includes 30 of the largest most influential companies in the US.
These 30 stocks represent only about 30% of the entire US market
2) The DJIA is share-price weighted meaning stocks with higher prices carry a heavier weighting in the average.
Share prices are arbitrary since they depend upon the number of shares issued. Example: Goldman Sachs, the most expensive stock in the average, has twice as much of an effect on the average than Apple, Inc. which has a market capitalization (measure of company size) of more than six times that of Goldman.
3) A committee selects the companies that make up the DJIA.
Formerly an industrial company average, this ceased to be when Sears Roebuck was added in 1924. Utilities and transport companies are excluded. The DJIA can lag the broader market significantly over long periods of time.
Despite these drawbacks, its name recognition seems to be the reason it is still quoted daily by news and financial media. When they say, “The stock market was up today”, they usually mean the DJIA.
For investment purposes, a better index would be the S&P 500 Index which is a market-cap weighted index representing about 80% of the US market. The S&P 500s greater diversity means that its movement provides a more accurate picture of changes in your stock portfolio.