Perhaps the most quoted stock index in the world is the Dow Jones industrial average, the “DJIA.” First published in 1896, it’s the oldest stock index, and the underlying benchmark for ETFs such as the SPDR Dow Jones Industrial Average ETF Trust (DIA).
But when people ask me, “What did the ‘Dow’ do today?” I always respond that I don’t follow that index. Why? It’s unrepresentative of the U.S. stock market.
On Monday, March 11, I was visiting my father. While markets were still open, he commented how strange he thought it was that the S&P 500 Index was up at the same time the DJIA was down. I suspected it had something to do with Boeing and the Ethiopian crash of the Boeing 737 MAX. It appeared my hypothesis was right, yet I had no idea what a perfect illustration of the problem with DJIA this was.
Boeing Example Of DJIA’s Shortcoming
Boeing is not only one of the merely 30 stocks in the DJIA, it carries the most weight of any single stock in the index. As of market close on March 8, 2019, Boeing (BA) accounted for 11.26% of the index, while Pfizer (PFE) accounted for about 1.09%, according to a spokesperson from S&P Dow Jones Indices. But the two companies had nearly identical total valuations (market capitalization) at just under a quarter trillion dollars each.
The DJIA is a price-weighted average, meaning the prices of the 30 stocks are added together. At the market close on March 8, 2019, Boeing traded at $422.54 per share, while Pfizer was priced at $40.89. Obviously, Pfizer had more than 10 times the number of shares outstanding. But a 1% decline by Boeing would have a larger impact than a 10% decline by Pfizer.
In the week ended March 15, 2019, Boeing lost 12.2% of its value in a drop that had a significant impact on the DJIA. In fact, it had a greater impact than if Pfizer stock had fallen to zero.
DJIA Vs. S&P 500
All in all, that week when Boeing stock plummeted, the DJIA still managed to gain 1.70%, but that was barely half the 3.14% gain the S&P 500 saw in the same period.
The S&P 500, in addition to having 500 companies rather than 30, is weighted by market capitalization. As of March 19, 2019, Boeing accounted for only 0.83% of this index, and Pfizer represented 0.98%. Broader indexes such as the Dow Jones U.S. Total Stock Index or the Wilshire 5000 track well over 3,000 stocks, and neither Boeing nor Pfizer account for more than 0.8% of these indexes.
Lessons Learned About Narrow Index & ETFs
I’m of the opinion that we remain tethered to the DJIA out of inertia, and inertia is a powerful force—I often argue the most powerful force in the universe. When the DJIA was conceived in the late 1880s, it was a task to add the prices of a handful of stocks. Today computing power and the internet make calculating market capitalization of hundreds or even thousands of stocks a snap.
Boeing’s bad week clearly demonstrates the folly of throwing too much of your money into any one stock or even 30 stocks. Don’t take uncompensated risk by owning narrow ETFs. Broader is better.
I recommend choosing the broadest U.S. stock index funds like the Vanguard Total Stock Market ETF (VTI) or the iShares Core S&P Total U.S. Stock Market ETF (ITOT). These are really broad, market-cap-weighted portfolios, serving up marketlike risk.
If you worry that weighting an index based on market capitalization will overweight certain companies and that other approaches work better, you’re probably presuming you’re smarter than the market. In reality, smart beta isn’t always as smart as it sounds.
Finally, examine what other roles inertia may be playing in your investments. Ask yourself whether you’re doing something because it’s right or because you’ve always done it that way, like being glued to the DJIA.
(Disclosure: I own a mutual fund share class of VTI.)
Allan Roth is founder of Wealth Logic LLC, an hourly based financial planning firm. He is required by law to note that his columns are not meant as specific investment advice. Roth also writes for CBS MoneyWatch.