The Dow Jones Industrial Average is a market index of 30 blue-chip U.S. companies covering most sectors of the economy, except transportation and utilities. Although the Dow does not represent all U.S. companies, it accurately tracks the performance of broader market averages and usually sets the tone for global stock markets.
The Dow Jones Industrial Average is a price-weighted index. You add the closing prices of each stock and divide by a divisor, which is adjusted for changes in the index. The base value was 40.94 on May 26, 1896, according to a fact sheet published by S&P Dow Jones Indexes. On May 25, 2012, the Dow closed at 12,454.83, representing a compounded annual growth rate of 5.05 percent over 116 years. However, the stocks in the index have changed over the years. In fact, of the 12 initial companies, only General Electric is still a Dow stock. The performance data over certain periods are more informative. For example, the historical data suggest that the Dow had a compounded annual growth rate of 7.55 percent from a close of 2,002.85 on Jan. 8, 1987 to a closing value of 12,359.92 on Jan. 6, 2012, just 25 years later. The data also suggest that the compounded annual return was about 4.3 percent over the 91 years before 1987.
The Dow is a widely followed and reported index because it is a reasonably accurate reflection of overall stock market performance. Although it has only 30 stocks, the index performs similarly to indexes that have hundreds of stocks. These indexes include the Dow Jones U.S. Total Stock Market Index, which covers virtually the entire U.S. stock market, and the S&P 500, which covers 500 of the largest U.S. companies across all economic sectors. Major global indexes, such as the Japanese Nikkei 225 and the German DAX, tend to follow significant up and down price movements in the Dow.
Corporate earnings and economic indicators influence Dow returns. Companies make money when interest rates and inflation are low, and when employment and spending levels are high. Conversely, rising interest rates and high unemployment lead to declining profits, which lead to lower stock market returns. Global economic and geopolitical events can also affect Dow returns because of the increasingly global and interconnected nature of businesses and financial markets.
Active investing involves picking individual stocks at bargain prices and trying to outperform benchmark indexes, such as the Dow Jones. If you do not have time to research and monitor individual stocks, you can buy index mutual funds and exchange-traded funds that track various market indexes. These funds do not have high fees and expenses, because the fund managers do not have the same research trading expenses as do the management of actively managed funds. For example, the Dow Jones Industrial Average ETF -- ticker symbol "DIA" on the New York Stock Exchange -- will have virtually the same annual return as the Dow index, and you can trade it just like any other stock.
- new york stock exchange image by Gary from Fotolia.com