The Dow Jones Industrial Average is Antiquated

Ryan Heshmati

March 15, 2024

Finding funds with the benchmarks of major indices like the Nasdaq Composite or the S&P 500 is not particularly difficult. For instance, SPY, IVV, and VOO are all ticker symbols for low-cost S&P 500 ETF trackers. However, that does not carry over to the Dow Jones Industrial Average (DJIA), which really only has one major fund tracking it: DIA. There is an explanation: The Dow is not a particularly effective measure of the overall market. 

The Dow Jones Industrial Average, which has existed since the late 19th century, comprises thirty companies chosen by a committee that, while not reliant on quantitative factors like the S&P 500, considers the totality of circumstances around companies up for consideration. Since there are also separate Dow Jones utilities and transportation averages, stocks falling in those categories are not considered. Beyond the potential problem of only thirty companies not being sufficient enough to encapsulate the overall market, the major issue is how included stocks are weighted.

Unlike the S&P 500, which weights stocks based on market capitalization, the larger a company, the larger its weight, the Dow Jones Industrial Average uses share price. Share price is an incredibly arbitrary means of determining index weighting. With share-price-based weighting, a company that is 1/100 the size of another can have a larger share price and, thus, a larger weight by having fewer shares issued despite making up a smaller share of the overall market. While not as extreme as the hypothetical above, UnitedHealth Group, valued at under half a trillion dollars, takes up well over double the weight of Apple, valued at over five times UnitedHealth Group, for no other reason than its high share price. 

It is worth noting that however arbitrary the weighting might be, returns over time have been compelling. DIA’s annualized returns since inception in 1998 stand at around 8.5%, which is certainly nothing to sneeze at. In fact, a portfolio backtesting simulation indicates that during the same period, an investment in the S&P 500 ETF SPY would have underperformed DIA by around half a percentage point annually.

The Dow Jones Industrial Average may be one of the oldest trackers of the overall market, but that does not mean it was ever a particularly good one. The weighting based on share price makes the DJIA quite difficult to take seriously as an overall market indicator. Even more difficult to justify, with the arbitrary weighting in consideration, is investing in DIA, even with its slight outperformance since 1998.