What the heck is the DOW?
For many people, “the DOW” is one of those terms that when you hear it on TV or read
it in an article, your eyes glaze over and your mind wanders to something more relevant
to your life, like whether you could fit 12 marshmallows in your mouth at once.
But how do you know you don’t need to know what the DOW is… when you don’t know what
the DOW is?
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In the late 19th century, a newspaper editor named Charles Dow and a statistician named
Edward Jones wanted to create a simple tool for how the U.S economy was doing day-to-day.
Since most of the economy was industrial at the time, they decided to combine the stock
prices of the twelve biggest industrial companies into one statistic: the Dow Jones Industrial
Average.
Those twelve companies were: American Cotton Oil Company, American Sugar Company, American
Tobacco Company, Chicago Gas Company, Distilling & Cattle Feeding Company, Laclede Gas Company,
National Lead Company, North American Company, Tennessee Coal, Iron and Railroad Company,
U.S. Leather Company, United States Rubber Company, and the only one still on the DOW
today: General Electric.
Today, 30 companies make up the DOW, and their combined share prices are used as an index,
or a benchmark, not just for how the stock market is performing in general, but also
how specific companies are performing compared to the market.
So, for instance, if you own a blue-chip stock that’s holding steady while the DOW is going
down, you can say that your stock is outperforming the market.
But wait a minute. There's almost 4,000 companies being traded on the U.S. stock market.
How could just 30 provide a reliable snapshot, no matter how big they are?
That’s a valid question.
Some people think the DOW’s importance has been blown way out of proportion.
After all, these 30 companies can be doing well when most Americans are hurting, like
in the case of massive layoffs.
And, as you’ve probably already noticed, they do a LOT of business overseas, so their
share prices don’t necessarily reflect the strength of the American economy.
So why do cable news hosts still endlessly refer to it as if it’s the be-all end-all
of market measurement?
Well, the stock market’s a funny thing.
Since its gains and losses are driven largely by whether people are deciding to buy or sell,
what’s actually happening in the economy is less important than what people think is
happening.
An individual stockbroker is trying to guess what all the other stockbrokers are going
to do.
But all the other stockbrokers are thinking the exact same thing.
Each investor needs to watch the DOW simply because he or she knows that every other investor
is watching the DOW--the starting point of an endless guessing game that often leads
to overreactive bubbles and plunges.
Adam Davidson of the New York Times called the DOW an “anxiety amplification device”.
So do you need to worry about the DOW?
Should you track it like a hawk, updating your 401(k) with every news story?
Or should you just ignore it?
Neither.
Knowing what the DOW is… and isn’t, will help protect you from the hysteria that can
dominate the news in times of worry.
But you should know that it’s just one of many indicators of how things are going in
the U.S. economy - like GDP, employment numbers, and Treasury Interest Rates.
Maybe we should take a cue from the man who it’s named for - Charles Dow was observed
to rarely look at the index himself.
And the executive director of Dow Jones Indexes, John Prestbo, recommended that the average
investor should only look at the index around once a quarter, or once a month at the very
most.
So the next time you hear someone on cable news yelling about the DOW… now that you
know what it is, you can probably go back to what you were doing.
And that’s our two cents!