Question: Whenever I hear a stock market report on radio or TV, the commentator mentions the Dow. It recently topped 20,000. Is the Dow a realistic proxy for the stock market?
Answer: Because you hear commentators quote the Dow so often, you might tend to associate it with the overall performance of the stock market. But in reality, the Dow is just one small part of a big picture. “The Dow” is short for the Dow Jones Industrial Average (DJIA). The Dow is a market index, and an index is a composite performance measure of a group of securities. Developed in 1884, it is by far the oldest market index in the United States. The Dow represents only 30 of over 20,000 stocks in the Morningstar U.S. stock database. Those 30 stocks, in the opinion of the Dow Jones Wall Street Journal editors, are the leading publicly traded industrial companies in the country. They do not represent the broad U.S. stock market. Commentators talk about other indices and I’ll explain four of the more common ones below.
The Standard & Poor’s Composite Index of 500 Stocks (S&P 500) is probably more useful and a more accurate measure of stock market activity. Started in 1957, it contains a broad cross-section of industries, and represents about 80% of the total market value of all American stocks. Many index mutual funds are patterned after the S&P 500 and most large U.S. equity funds will compare their performance to it.
The Standard & Poor’s Mid-Cap 400 (S&P 400) is similar to the S&P 500 but is designed to track mid-size companies. This index was designed in 1991 and is a better benchmark if you invest in middle-sized firms.
The Nasdaq Composite index measures the performance of more than 3,000 stocks that trade on the Nasdaq computerized trading system. A common misconception about this index is that it measures the performance of smaller companies. It’s true that many small companies are traded on the Nasdaq, but so are some of the big technology companies. Microsoft, Apple, Google (aka Alphabet), Oracle, and Amazon are all traded on the Nasdaq. These bigger technology stocks tend to dominate the direction of this index. If your mutual fund or stock portfolio holds a lot of large technology stocks, the index may be a good benchmark for it.
The MCSI Europe/Australasia/Far East Index (EAFE) tracks the major stock markets across 21 developed markets outside the U.S. The U.S. represents about 40% of the world’s capital markets, meaning 60% of the worlds market capitalization resides outside the United States. Europe represents 19.5% of the world capital market; Asia represents 33.3%; Australia 1.75%; the middle east 2.0%; and Africa 1.5%. EAFE only includes the large and mid-cap stocks in each market, and does not include any emerging or developing market companies (e.g., China and South Korea are not included in the EAFE index). These constraints make the EAFE index an imperfect proxy to use as an index to compare your international portfolio to, because it may not be representative of your holdings. There are other international indices you can take a look at, such as the Dow Jones Global ex-U.S. Index, that may suit your needs.
Kenneth B. Petersen CFP®, EA, MBA, AIFA® is an investment advisor and Principal of Monterey Private Wealth, Inc., a Wealth Management Firm in Monterey. He welcomes questions that you may have concerning investing, taxes, retirement, or estate planning. Send your questions to: Ken Petersen, 2340 Garden Road Suite 202, Monterey, CA93940 or email them to firstname.lastname@example.org.