Dinosaur or diamond? Dow Jones Industrial Average turns 125

Has the index become too long in the tooth for investors looking for a US index to track?

The Dow Jones Industrial Average of 30 large US companies today celebrates a huge milestone, marking its 125th anniversary.

Constituents include the likes of Apple Inc (NASDAQ:AAPL), Nike (NYSE:NKE), Boeing (NYSE:BA), Johnson & Johnson (NYSE:JNJ), McDonald's (NYSE:MCD) and Microsoft (NASDAQ:MSFT). Procter & Gamble (NYSE:PG) joined the index in 1932, along with Coca-Cola, although the latter has been in and out of the index. In a recent interactive investor interview,Bill Ackman of Pershing Square Holdings described Coke as having “probably cost more economic harm than almost any company in the world by its hoarding sugar water and therefore obesity and diabetes all over the world. I think it’s a great company, it’s very well run, I just don’t love the product and the health implications.”

General Electric had the longest continuous presence on the index, beginning in the original index in 1896 and ending in 2018.

Despite the broad range of companies in the index (the constituents of which many will have their own individual view on) and its historical importance, interactive investor, the UK’s second-largest DIY investment platform, believes that it has become long in the tooth for investors looking for a US index to track.

Passive options tracking the broader US market that interactive investor like include Vanguard US Equity Index (from its Super 60 rated list), which tracks the S&P Total Market index. The fund buys most of the underlying stocks but optimises its holdings of some of the smaller companies to generate performance that matches the index, while keeping costs to a minimum. It distributes income annually and its ongoing charge is 0.1% making it a very cheap fund to access the whole US equity market.

For investors who want to invest in the US from an ethical perspective, interactive investor also likes iShares MSCI USA SRI ETF USD (LSE:SUUS) (from its ACE 40 ethical rated list).Tracking the MSCI USA SRI index, it includes only companies with high environmental, social and governance (ESG) ratings above a predetermined level and the ‘USD Acc’ share class levies annual ongoing charges of 0.20%.

Tom Bailey, ETF Specialist, interactive investor, says: “Being one of the oldest indices in the world, the Dow Jones Industrial Average (DJIA) has great historical importance and is still quoted by many looking to measure the performance of the US market today. Its long history also means that it is a great tool for making historic market comparisons.

“However, for investors today, the DJIA is better seen as a historical relic and should not be used to track the US market. There are several reasons for this. First, the DJIA is surprisingly small, with just 30 stocks. It has been like this since 1928 and is unlikely to be increased any time soon.

“Second, the DJIA is “price-weighted”. This means that the trading price of a stock determines how much of the index it makes up. Most would agree that this method of weighting is inferior to a market-capitalisation weighting, in which the proportion that each company represents in the index is the result of its share price multiplied by the number of shares in circulation.

“On top of this, strange stuff can happen when an index is weighted by price. For example, Apple spent the first half of 2020 as the largest weighted company in the DJIA. However, in the summer of that year, it carried out a four-for-one stock split. As a result, Apple’s weighting in the index fell.

“The Apple stock split would have reduced its weight in the DJIA from 12.2% to 3.4% and increased the weight of the other 29 members by around 10% each. It would also have cut the index’s tech sector weighting by around 7%. In a market-cap weighted index, the stock split would have had no effect on the weighting of either Apple, or the overall tech sector.

“In response, the managers of the of DJIA index added Salesforce, at the expense of another constituent. The tech exposure of the index is still below where it was before the Apple stock split, and Apple’s weighting is still significantly smaller than it would have been if it had not split.

“Is this how passively investing in a broad market index is meant to work? Do investors tracking an index really want the weightings determined by stock splits and chosen replacements?

“Finally, index funds and ETFs tracking the DJIA tend to be more expensive than those tracking other broad market US indices.

“The DJIA is a great piece of financial history and I hope that it continues to be maintained and calculated. But those looking for a US index to track, it is better to go with one of the large market-cap weighted alternatives such as the S&P 500 or the MSCI USA index.”