Monday, October 7, 2013

What is this "Dow" thing everyone keeps talking about?

Prices go up and down, but just looking at individual
stocks doesn't always give you the best idea of what's going on!
Read this if: 

1) You are curious about that "Dow" thing you always hear about on the news. 

---

I'm in college now so I don't get in a car often. But before that, whenever I was in the car with my parents, they'd listen to the radio and someone would be talking about the Dow. I am going to explain what that is and what it means when it goes up or down. 


What is an index? 

The Dow is an example of a market index, which I like to think of like the weather forecast. It's nice to know when it's gonna be sunny or rainy. Sometimes there are unexpected weather patterns and you could be caught off guard and then your pants get wet but yo have to go to class anyway. The indices (there are several of them) give us a general idea of how the economy is doing, but sometimes unexpected things happen. 

How is it computed? 

Each index has their own way of tracking the market. For example, the Dow Jones Industrial Average tracks 30 [of the] largest stocks in the United States. If "the Dow" goes up, that means the weighted average price of a share has increased, which is good for anyone who has invested in it. Another example is the S&P 500, which is an index that tracks 500 of the largest companies. There are tons of other indices out there, including: the NYSE and NASDAQ (the only two I have heard of). There are indices that track specific sectors, which makes them less diverse. 

So what's an index fund?

An index fund is a mutual fund with much lower cost. The fees are lower because these funds are managed by computers that track an index like the S&P 500, instead of having a person "actively" choose what the fund invests in. 

Why does it matter to you? 

If you understand indices and know what they track, you can make an educated decision when purchasing shares in index funds. This will also help you maintain a balanced and diverse portfolio. 

Let's say you buy two different index funds, Fund A and Fund B. You think that because you have two different funds, you have a pretty diverse portfolio, which is always good for minimizing risk. However, what you don't know is that both funds track the S&P 500 so you actually bought two different funds that invest in the same things anyway. That's why it's always a good idea to read about what your funds invest in. 

--

As always, contact me with questions or suggestions! You can either comment directly on the post or send me an email to moneymattersjoan@gmail.com. 

Photo Credit: francisco.j.gonzalez via photopin

2 comments:

  1. It is worth noting that although the Dow Jones Industrial Average (DJIA) and the S&P 500 average both are measure of large capitalization American stock averages, they are quite different measures. The DJIA is rooted in a nineteenth century methodology that in which calculations were made my hand (yes, pencil and paper, maybe with a sliderule, what that was, thrown in for good measure :~).


    The DJIA is an average of stock prices of 30 large cap stocks; as such, a stock whose price is $100 per share influences the average more than a stock whose price is $10 per share.



    The S&P 500, on the other hand, is weighted by market capitalization (the price per share multiplied by the number of shares outstanding- actually I think it's the number of shares available to be traded on public exchanges). Calculating something like the S&P 500 average on a daily basis would have been a daunting task in the 19th century.


    So, while the DJIA is a widely quoted average, it reflects a rather narrow slice of the total equities market. I regard it as an anachronism that is retained mainly because it is a familiar market index, while the S&P 500 is a much more meaningful index in today's world.

    ReplyDelete
  2. Thanks for reading and commenting! I'm going to write another post based on the information you gave, so thanks for giving me content ideas!

    ReplyDelete