The Dow Jones Industrial Average as a Benchmark.

A benchmark is generally a group of investments referred to as an index. The most common index used as a benchmark is the Dow Jones Industrial Average. It is frequently referred to as the DJIA or just the Dow. When news reports refer to how the market is doing, they usually quote the performance of the Dow. However, using the Dow as a benchmark might not be the best comparison for all investments.

One of the most important questions that an investor can ask is “how did my investments do?” The next question that one should ask is how do you compare investments to determine if your returns are good or bad? To answer this question, it is essential that you compare your investments to a benchmark that is made up of similar holdings.

The Dow Jones Industrials Average Index began around 1892 and at that time it only had twelve stocks. Surprisingly the Dow only has thirty stocks today. However, do not let the small number of stocks fool you. The thirty stocks in the index are the largest companies in the United State’s economy and represent a variety of industries. The market value of the index is approximately 6.662 trillion dollars (Siblis Research, 2018, April 2). Barron’s estimates the value of the entire US market at about 30 trillion dollars (Racanelli, 2018, January 18). With nearly twenty percent of the economy represented, it is easier to see that the trend of these thirty companies is an indicator of the direction of the overall economy.

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That does not mean that the Dow is an appropriate index for every investment. If you are investing in large company stocks; yes, it is a good benchmark. Investment advisers try to use an index that correlates closely with the investment being analyzed.

There are problems with using the Dow as a benchmark. The most significant drawback to the index is that it is price-weighted. Stocks with the highest relative price have the most effect on the value of the index. You can see in the accompanying graph that the most influential stock in the index is Boeing and the least is General Electric. If you are buying investments that have positions in companies similar to these, it is a good benchmark.

What if you have a bond fund or a natural resources fund? When selecting a benchmark to evaluate an investment’s performance, it is best to use one that closely correlates with the index. There are analytical statistics that can help in comparing benchmarks to investments. However, I’ll save that to be the subject for another day.

Posted by: Van Richards

Van is the founder of Advice4Retirement and Advice4LifeInsurance you can contact him at van@advice4retirement.com Follow on Twitter @VanRichards, Facebook at https://www.facebook.com/Advice4Retirement/and https://www.facebook.com/advice4lifeinsurance/ or LinkedIn at https://www.linkedin.com/in/vanrichards/

References

IndexARB. (2018, May 29). Index component weights of stocks in the Dow Jones Industrial Average. Retrieved May 30, 2018, fromhttp://indexarb.com/indexComponentWtsDJ.html
Racanelli, V. J. (2018, January 18). The U.S. Stock Market Is Now Worth $30 Trillion. Barron’s Magazine. Retrieved from https://www.barrons.com/…/the-u-s-stock-market-is-now-worth…
Siblis Research. (2018, April 2). Dow Jones total market cap. Retrieved May 30, 2018, from http://siblisresearch.com/data/dow-jones-market-cap/

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