An Average That Isn’t
VALUE STOCKS ARE having quite the year���at least relative to growth shares. This past week underscored that trend, with the value-oriented Dow Jones Industrial Average (DJIA) rising every day. Barring a big drop today, October will mark the index���s best monthly performance since 1976.
Even as the Dow rallied 5.7% last week, the growth-heavy Nasdaq Composite index rose just 2.2%. For the year, the Nasdaq is down 29%, versus less than 10% for the Dow.
Should you allocate some of your portfolio to the DJIA? I don���t think that���s the most effective way to invest. The Dow is a price-weighted index. That means the higher the stock price of one of the Dow���s components, the heftier its weight in the index. By contrast, most index funds weight their holdings by each company���s market capitalization���the stock price multiplied by the number of shares outstanding.
For example, the biggest holding in the Dow is UnitedHealth Group (ticker: UNH) at more than 11%. But that stock is just 1.6% of the S&P 500. What about America���s biggest stock by market capitalization, Apple (AAPL)? After reporting strong third-quarter earnings last Thursday, I calculate it accounts for 6.9% of the S&P 500. But Apple is just 3% of the DJIA, making it the 15th biggest holding among the Dow 30.
Overall, the Dow has 19.4% in the growth-oriented tech sector, compared with the S&P 500���s 25.9%. Meanwhile, the more defensive health care sector is 22.2% of the Dow, but just 15.3% of the S&P 500. The DJIA���s larger relative positions in financials and industrials also give it more of a value flavor.
Still, over the long haul, the DJIA and S&P 500 boast similar returns. A lot of ink has been spilled deriding the DJIA���s price-weighted construct and, indeed, I���ve been among the critics. But in reality, what really matters is being invested.
Since 1998, SPDR Dow Jones Industrial Average ETF (DIA) has returned 545%, while the SPDR S&P 500 ETF (SPY) has notched 523%. Even broad market funds, such as Vanguard's Total Stock Market Index Fund (VTSAX), have had similar returns to the Dow. The upshot: While such index funds have different holdings, their performance tends to converge over the long term���and investors should fare just fine with any of them.
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