How To Invest In the Dow Jones Industrial Average

The Dow Jones Industrial Average is one of many stock indices that track the performance of the stock market or some segment of it. In the case of the Dow Jones Industrial Average, also called simply the Dow or the DJIA, that segment is 30 of the largest publicly traded U.S. stocks, selected to reflect U.S. industry.

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The DJIA is an index, and not a company in its own right, so you can’t buy shares. But you can invest in funds that track the index or in the companies that serve as its components.

What Is the Dow Jones Industrial Average?

The Dow Jones Industrial Average is the oldest and most continuously used benchmark for the U.S. stock market. The 30-stock index only includes major industrial-sector companies (other than utilities) listed on the New York Stock Exchange or Nasdaq. Otherwise, the criteria for inclusion are nonspecific, but the committee that selects the components considers the company’s reputation, history of sustained growth, interest to investors and how well its sector represents the broader market, according to S&P Dow Jones Indices.

The Dow traditionally has excluded extremely expensive stocks whose share prices are disproportionate to the company’s importance to the economy. That’s because the Dow is price-weighted, which means a company’s stock price determines how much influence it has on the index. So including a company like Berkshire Hathaway, which traded for over $542,000 at the close of trading on Dec. 4, would give BRK-A stock great weight on the index even though Apple, which traded for about $189 on the same day, is about 3.75 times larger in terms of market capitalization.

How To Invest In the Dow Jones Industrial Average

The Dow is not a company in its own right. That means you can’t buy stock in the index itself. However, you have three other ways to invest. You can purchase shares in an index mutual fund, an index exchange-traded fund, or you can buy individual stocks in the companies, called components, that make up the fund.

Investing In Dow Jones Industrial Average Mutual Funds

A mutual fund is a company that pools money from a group of investors to purchase securities that meet a specific investment goal, such as tracking the performance of an index like the Dow. This type of fund is called an index fund.

Whereas investors who purchase stock own shares of the company that issued the stock, mutual fund investors own a share of the fund. That means they profit when the fund does. For example, if the stocks within the fund pay dividends or interest, the fund distributes that income to the investors. Likewise, when fund managers trade fund holdings at a profit, the investors receive a proportionate share of the capital gains through distributions. When you invest in a fund, you can take your distributions in cash or reinvest them back into the fund.

It’s important to note that these distributions are after-expense — the mutual fund deducts its expenses from the income or gains before passing the rest on to investors. Additionally, you’ll pay tax not only on the distributions, but also on capital gains generated when the fund managers make a profitable trade within the portfolio.

A mutual fund’s price is expressed as a net asset value. The NAV is different than a stock price. Whereas a stock’s price reflects its performance, NAV performance is better reflected by longer-term trends — three to 10 years, according to Schwab. However, those trends are not predictive of future performance.

Pros and Cons of Investing In the Dow Jones Industrial Average With Mutual Funds

Mutual funds are a good choice for the right investor. However, it’s a good idea to consider their drawbacks before you invest.

Pros

• Mutual funds add automatic diversification to your portfolio because they contain a basket of stocks. Dow index funds might invest in some or all of the 30 companies that make up the Dow Jones Industrial Average.

• You get exposure to some of the largest and highest-quality stocks in the U.S.

• Mutual funds can produce both income and capital gains.

Cons

• Mutual funds have fees, which are expressed as an expense ratio of fees to the fund’s assets.

• Some mutual funds have high minimum investments, such as $1,000 or $3,000.

• Because mutual funds trade just one time per day, after the market closes, the price at which you place an order might differ from the price at which the order is executed.

• You incur tax liability when a trade within the portfolio generates a capital gain.

Investing In Dow Jones Industrial Average ETFs

Exchange-traded funds are similar to mutual funds in that they are companies that pool investors’ money to invest in a themed basket of stocks and/or other securities. In addition to potential appreciation of share value, your ETF investment might earn dividends, which you can have paid to you directly or reinvested back into the fund. When you invest in an ETF, you own a share of the fund, but you don’t own the stocks included in the fund.

Index ETFs are also similar to index mutual funds in that they’re passively managed — the fund managers buy and sell shares to mimic the returns of the index rather than to generate the largest gains.

One of the biggest differences between mutual funds and ETFs is that ETFs trade like stocks. You can buy and sell your shares whenever the market is open — which means you buy and sell for shares’ market value at the time you place the order if you trade when the market is open. Otherwise, the ETF could trade at a discount or premium.

The minimum investment in an ETF is its share price — or a fraction thereof, if the fund and your broker allow you to purchase fractional shares. That makes ETFs more accessible than some mutual funds. In addition, fees — expressed as the operating expense ratio — are often lower.

Pros and Cons of Investing In the Dow Jones Industrial Average With ETFs

ETFs carry their own benefits and risks.

Pros

• ETFs have no minimum investment other than the share price, and you might be able to trade fractional shares.

• An ETF adds instant diversification to your portfolio because the fund holds shares of many different companies.

• You can trade ETFs whenever the market is open.

• Profitable trades within the fund’s portfolio don’t generate capital gains tax.

Cons

• ETFs have fees, although they’re often lower than a mutual fund’s.

• You must hold an ETF for at least 60 days before the dividend payout for the dividend to be classified as qualified, which has a lower tax rate.

Investing In the Companies That Make Up the Dow Jones Industrial Average

You’d have to be a market expert to build a portfolio that replicates the Dow’s returns — essentially create an index within your portfolio. But you can take lessons from the companies the Dow includes in the index and use them to custom-build your own portfolio.

The companies operate in different sectors, but they all have certain traits in common. They all have large capitalizations, solid reputations and long histories of sustained growth — the very characteristics that define “blue chip stock.”

Investing in all 30 would be expensive, and the absence of small-cap, mid-cap and foreign stocks and other assets could rob your portfolio of the diversity financial advisors recommend. However, you could pick a few top holdings that represent different sectors.

What Companies Are Included in the Dow Jones Industrial Average?

Thirty stocks make up the Dow, with the most expensive having the most influence. Here are the top 10, along with their prices as of Dec. 4:

What Is the Average Rate of Return of the Dow?

Over the last 10 years, the Dow has averaged an 8.58% annualized rate of return, according to S&P Dow Jones Indices. That average underscores the importance of looking at stocks as a long-term investment, as returns in any given year can be much higher or lower. Here are the actual returns over the last 10 years, as cited by Macrotrends.

Is the Dow a Good Investment?

Considering that blue-chip companies make up the Dow, and the index has produced solid returns over time, financial advisors would likely tell you the Dow is a good investment — but not necessarily the best investment for your portfolio.

If your primary goal is to invest in tried-and-true blue-chip companies, a Dow index fund could be a good fit. The index has just 30 companies, and all of them are blue chips.

If, on the other hand, you’re looking for an index fund with the broadest possible exposure to the overall market, you might be better off with an S&P 500 index fund. The S&P 500 has 500 of the largest U.S. stocks, hand-picked by a committee. In addition to having more stocks, the S&P 500 is weighted by market cap rather than share price, so larger companies, and not pricier stocks, assert the most influence on the index just as they do on the market.

Data was compiled on Dec. 4 and Dec. 5, 2023, and is subject to change.

This article originally appeared on GOBankingRates.com: How To Invest In the Dow Jones Industrial Average