Time to Drop the Dow

By David Vomund

How much are stocks up this year?  That common question is getting harder to answer.  Many individuals look to the Dow Jones Industrial Average, which was established in 1896, when it comes to measuring the market.  Although it has a great history, it’s time to retire the Dow.  

The Dow is a price-based average so high-priced components like UnitedHealth ($497) play a far bigger role than Cisco ($46) and Walmart ($67).  That’s ridiculous.  Plus, there are only 30 stocks in the Dow.  

For those reasons the S&P 500 Index became the standard market measurement.  But it has flaws, too, and is increasingly sensitive to moves in a few stocks.  The S&P 500 is a capitalization-weighted index so the larger the company the bigger the influence it has on price.  

In recent years the largest companies have grown faster than others so the S&P 500 Index is greatly influenced by a few holdings.  The largest five stocks (Apple, Microsoft, Nvidia, Amazon, and Meta Platforms) control 27 percent of the index’s movement.  Technology stocks are nearly a third of the weighting.  Instead of showing what 500 stocks are doing, the S&P 500 is becoming a technology index.  

To show how five technology stocks are making the overall market look stronger than it actually is let’s look at this year’s return.  As of a week ago, the S&P 500 was at an all-time high with an impressive 14 percent year-to-date gain.  But the average stock in the S&P had a gain of just 4.2 percent.  The Dow Jones Industrial Average was up 2.4 percent, S&P Mid-Cap Index was up 4.3 percent and S&P Small-Cap Index was down 3.3 percent.  Clearly the S&P 500 is overstating the strength of most stocks.  

Congratulations to those invested in the S&P 500 because they’ve done better than the market (for most of my career that statement would make no sense!).  But those investors may be taking on more risk than they realize.  

Years ago investors who wanted a diversified equity portfolio could simply buy an ETF that tracked the S&P 500 Index.  They can’t do that now, however.  If a client asked me as an adviser to put them in a diversified equity portfolio and I bought five technology stocks with more than a quarter of the portfolio then I could surely be sued!  Should Nvidia and others continue to outperform like many expect then their influence will only get larger.  S&P 500 Index fund investors should understand that risk.

David Vomund is an Incline Village-based Independent Investment Advisor.  Information is found at www.VomundInvestments.com or by calling 775-832-8555.  Clients hold the positions mentioned in this article.  Past performance does not guarantee future results.  Consult your financial advisor before purchasing any security.