If you listen to any TV news station you will hear the current day's market activity related in terms of the Dow Jones Industrial Index ("the Dow.") The Dow represents 30 of the largest public companies, but is it a good representation of the "market" and, more importantly, should you use it to guage the performance of your portfolio?
The companies that comprise the Dow are chosen by a committee. Some criticisms of this process include the argument that companies are added after they have experienced their prime growth period, and evidence shows that new Dow stocks lose, on average, 20 percent of their value in the first year of inclusion. In addition the index is weighted according to share price, thus stocks with a higher share price have a higher weighting in the index. A $1 change in value of a higher-priced stock counts more than a similar change in a lower-priced stock. Does this make the index a good proxy for the stock market in general? Most advisors think the S&P 500 Index or Wilshire 5000 Index make better benchmarks.
It is just as important to remember that if you have a diversified portfolio of stocks and bonds, no one market index is going to represent the activity in your portfolio for a given day. If you have 60 percent in large company stocks and 40 percent in bonds and you see that the Dow (or the S&P 500 Index) are down a point, it is likely that your portfolio changed by about 6/10 of that point. Add to the mix your bonds, small company and foreign stocks and you can see that the Dow or any other large company index is not a good illustration of your portfolio.
So watch the day-to-day changes of the Dow with mild interest, but don't take it as an indication of the performance of your portfolio.
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