5 Facts You Never Knew About the Dow
With a 117-year history, the Dow Jones Industrial Average is still the only way that many people ever track the stock market. With 30 stocks and a straightforward way to calculate the average, the Dow appeals to investors with its simplicity while still including many of the most important companies in the U.S. economy.
But even though the Dow is closely followed, investors aren't familiar with all of its secrets. That's why Dow Jones Indexes came out with a brochure (opens a PDF) that provides some little-known facts about the Dow. Let's take a look at five of them.
1. Who makes decisions about the Dow?
An entity called the Averages Committee makes all the major decisions about the Dow, particularly which companies will be admitted to the average. The committee has three members: the head of Dow Jones Indexes research, the head of CME Group research, and the managing editor of The Wall Street Journal. CME Group bought a 90% stake in Dow Jones Indexes back in 2010 in a deal that valued the business at $675 million and gave the exchange a strong position in offering products like futures contracts that are tied to the Dow.
2. The Dow has thought about including more stocks.
The Dow started with 12 stocks. It grew to 20 in 1916, and by 1928, it had its current membership of 30. The Dow considered a proposal to grow further to 50 stocks, but as Dow Jones Indexes explains, "the number of stocks is not nearly as important as which ones we pick." The Averages Committee therefore chose not to make the change, and it seems unlikely that it will do so in the near future.
3. The Dow has considered changing its price-weighting method.
Many investors argue that the Dow's price-weighted calculation is outdated, pointing to rival indexes such as the S&P 500 that use market-cap weighting. But even though it has considered a shift in the past, Dow Jones Indexes is more pragmatic about the price-weighted method, noting that even if you looked back a decade at the market's performance, the returns of a hypothetical market-cap-weighted Dow wouldn't be much different from the actual returns of the price-weighted Dow. In fact, the real Dow outperforms the hypothetical index slightly, and citing the tendency of market-cap-weighted indexes to overweight hot stocks, Dow Jones Indexes doesn't foresee making changes.
4. The Dow made as many changes from 2001 to 2010 as it did from 1941 to 1980.
The Dow has a reputation for stability, sometimes raising criticism that the Averages Committee is too reluctant to make substitutions. But lately, changes in the Dow have come at a faster pace than they have at any time the Great Depression. Still, the Dow prefers not to make changes unless they find replacements "compelling or unavoidable," citing the addition of tech giants Intel and Microsoft in 1999 as an example of a compelling replacement and various mergers and bankruptcy proceedings as examples of unavoidable ones.
5. The Dow's returns are highly correlated to other large-cap indexes.
Looking back 25 years from 1986 to 2011, Dow Jones Indexes analyzed the correlation of its monthly returns to those of other major large-cap indexes. What it found was that for the most part, the Dow traded largely in line with those indexes, with correlations running between 93% and 96%. That analysis further responds to criticism that the Dow isn't relevant anymore.
Learn more about the Dow
The Dow is deceptively simple, but the effort that goes toward putting the average together is extensive. Knowing facts that most people don't about the Dow won't necessarily give you better returns, but it will give you a different perspective on investing generally and on market benchmarks in general.
The article 5 Facts You Never Knew About the Dow originally appeared on Fool.com.Fool contributor Dan Caplinger has no position in any stocks mentioned. You can follow him on Twitter: @DanCaplinger. The Motley Fool recommends Intel and owns shares of Intel and Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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