Ever wonder what the Dow Jones Industrial Average is and why it’s so important? You’ve probably heard news anchors drone on about how “The Dow rose 200 points today” or “The Dow plunged in early trading.” But what does it all mean and why should you care? The Dow Jones, as it’s commonly called, is one of the oldest and most-watched stock market indexes in the world.
It tracks 30 of the largest companies in the U.S., from American Express to Walmart, to give you a quick sense of how corporate giants and the overall stock market are performing on any given day. While there are lots of indexes out there, the Dow remains front and center, for better or worse.
So if you want to understand what’s happening in the economy and be an informed citizen, it pays to understand the ins and outs of this ubiquitous benchmark. This article will give you everything you need to know about the Dow Jones Industrial Average so you can watch the markets like a pro.
What Is the Dow Jones?
The Dow Jones Industrial Average (DJIA), also known simply as “the Dow,” is one of the most well-known U.S. stock market indicators. It tracks 30 large companies listed on stock exchanges in the United States. The Dow is a price-weighted index, so companies with higher stock prices have more influence on the average.
The Dow Jones was created in 1896 by Charles Dow and originally tracked 12 companies. It has since been expanded to 30 companies from various industries like technology, retail, financials, and industrials. Companies in the Dow are leaders in their industries and play an important role in the economy. Some of the companies in the Dow include Apple, Microsoft, Walmart, Johnson & Johnson, and American Express.
The Dow is used to measure the performance and health of the stock market and gives insight into the performance of the overall U.S. economy. If the Dow is up, it signals that investors are confident and companies are profitable. If it’s down, it could indicate economic uncertainty or a market correction. The Dow influences investor sentiment and confidence.
While the Dow only represents 30 companies, it is still closely watched as an indicator of the stock market and economy’s strength or weakness. The Dow has endured crashes like Black Monday in 1987 and the financial crisis of 2008 but has always recovered over the long run. For better or worse, the venerable Dow Jones Industrial Average remains an integral part of financial history and continues to shape investor psychology.
History of the Dow Jones Industrial Average
The Dow Jones Industrial Average, or DJIA, is one of the most well-known stock market indexes. It’s been around since the late 1800s, so it has a long and storied history.
The original Dow Jones Index was created in 1884 by Charles Dow, Edward Jones and Charles Bergstresser. This was called the Dow Jones Railroad Average and tracked only railroad stocks.
The DJIA as we know it today began on May 26, 1896. It started with just 12 stocks, representing major American industries like cotton, tobacco, gas, sugar, and banking. Over time, components were added and removed to reflect the changing economy.
The DJIA has seen it all – it weathered the Great Depression, several recessions, two world wars, the dot-com bubble and the financial crisis of 2008. Despite many ups and downs, the DJIA has increased an average of about 5.6% per year since its inception.
The 30 large companies that make up the DJIA today are household names, like Apple, Coca-Cola, McDonald’s, and Walmart. The DJIA is a price-weighted index, meaning higher priced stocks have a greater influence on index performance.
Even after over a century, the Dow Jones Industrial Average remains an important indicator of the health of the stock market and the economy as a whole. For new and seasoned investors alike, following the DJIA is a great way to track market trends and see how some of the biggest public companies are performing.
How the Dow Jones Is Calculated
The Dow Jones Industrial Average, or DJIA, is one of the most well-known stock market indices. It tracks 30 large companies listed on stock exchanges in the United States. But how exactly is the Dow Jones calculated?
The Dow Jones is a price-weighted index. This means that higher priced stocks have a greater influence on the index’s value. The stock prices of the 30 companies are simply added together and divided by a divisor to calculate the Dow Jones’ value.
The divisor, currently around 0.14748071991788, is a number used to adjust the Dow Jones calculation for things like stock splits, spin-offs or mergers to ensure continuity over time. The divisor allows the value of the Dow Jones to remain consistent even when there are major corporate changes that affect individual stock prices.
To calculate the Dow Jones Industrial Average, here is the basic formula:
- Add the stock prices of the 30 companies
- Divide the total by the divisor
Company A stock price: $200
Company B stock price: $150
Company C stock price: $100
Total of stock prices = $200 + $150 + $100 = $450
Divisor = 0.14748071991788
Dow Jones Industrial Average = $450 / 0.14748071991788 = 3058.53
So the DJIA would be 3058.53 in this example. The actual calculation is a bit more complex, but this covers the essential methodology. By following the stock prices of major companies, the Dow Jones aims to reflect the health of the overall U.S. economy and stock market.
Major Milestones and Crashes of the Dow
The Dow Jones Industrial Average has experienced tremendous highs and lows over its history. Some of the major milestones and crashes of the Dow have defined entire decades.
The Roaring ‘20s and the Crash of 1929
The 1920s was a decade of economic growth and social change. New technologies like the automobile, telephone, and radio were transforming life in America. The stock market and the Dow were soaring. By 1929, the Dow had climbed over 300% in just six years. However, the exuberance couldn’t last.
In October 1929, the overheated stock market began a steep decline. Panic set in, and on October 24, “Black Thursday,” the Dow plunged 11%. The following week, on “Black Tuesday,” the Dow fell nearly 13% in a single day. The crash marked the start of the Great Depression, wiping out millions of investors. The Dow wouldn’t return to 1929 levels for another 25 years.
The Go-Go ‘80s and Black Monday
The 1980s saw a long bull market and period of economic prosperity. New financial instruments like junk bonds and leveraged buyouts fueled speculation. The Dow surged, gaining over 1,400% between 1982 to 1987.
On October 19, 1987, the party came to an abrupt end. The Dow suffered its largest one-day drop, plunging nearly 23% in a single day. The reasons for the crash were numerous — program trading, overvaluation, and market psychology. But the economy proved resilient, and the bull market continued for another decade.
The Dot-Com Bubble and Burst
In the late 1990s, the Internet was transforming industries and lives. Excitement over dot-com companies caused their stocks to soar, and the Dow rose over 300% between 1995 to 1999. The bubble burst in 2000. Many dot-coms went bankrupt, investor enthusiasm faded, and the Dow declined nearly 40% over the next two years. The burst led to a mild recession but set the stage for future growth.
The history of the Dow is a story of cycles — long periods of growth fueled by innovation and speculation, followed by crashes that remind us that what goes up must come down. But over the long run, the Dow has always recovered and gone on to new heights.
How to Invest in the Dow Jones Index
Investing in the Dow Jones Industrial Average is a great way to get exposure to 30 of the largest U.S. companies. Rather than buying shares of each company individually, you can invest in index funds or ETFs that aim to match the Dow’s performance.
Index funds and ETFs
Index funds and exchange-traded funds (ETFs) pool money from many investors to buy shares that replicate the Dow. Popular options include the SPDR Dow Jones Industrial Average ETF (DIA) and the Vanguard S&P 500 Index Fund (VFINX). These provide broad market exposure so your investment rises and falls with the Dow. The fees are low since the funds are passively managed.
To invest, you’ll need a brokerage account to purchase shares. Many mainstream brokers like E*Trade, TD Ameritrade, and Charles Schwab offer access to Dow index funds and ETFs. You can open an account on their websites and fund it by linking your bank account. Most brokers charge minimal trading commissions, if any.
How much to invest
Decide how much you want to invest, keeping in mind that index funds require a minimum amount, often $1,000-$3,000 to get started. Contribute regularly to take advantage of dollar-cost averaging. Even putting in $50-$200 a month can go a long way over time thanks to the power of compounding returns.
The Dow has historically gained over 7% annually after inflation. However, the market is volatile, so your investment may rise and fall a lot over short periods. The key is to stay invested for the long run. Over decades, the ups and downs smooth out, and you’ll benefit from the overall upward trend. Periodic rebalancing and reinvesting dividends will also boost your returns.
Investing in the Dow Jones is ideal for long-term goals like retirement. While there are no guarantees, the Dow has reliably built wealth for generations of investors. By using low-cost index funds, you can invest alongside the biggest companies on Wall Street and aim for solid returns.
So there you have it, a quick crash course in the Dow Jones Industrial Average and what it means. You now know what stocks make up the Dow, how it’s calculated, and why it matters. The next time you hear a news anchor excitedly announce that the Dow broke another record or took a big tumble, you’ll understand exactly what they’re talking about and why it’s important.
Staying on top of the major stock indexes like the Dow is a great way to keep your finger on the pulse of the overall economy and see how optimistic or pessimistic investors are feeling. While the Dow isn’t the be-all and end-all of the stock market, it remains an influential barometer of America’s economic health and prosperity. Keep watching the Dow—it’s sure to be an interesting ride.