Why did the housing mess clobber my 401k?

What does the DOW number actually represent?
— Mary, Berlin, Md.

By itself, not a lot. The Dow Jones Industrial average — though it is the most widely followed measures of the performance of the U.S. stock market — actually tracks just a handful of the thousands of stocks traded minute-by-minute on Wall Street and around the world. Developed over a 100 years ago by a fledgling financial news service, there were originally just 12 stocks used to calculate how market prices moved. Over the years the company developed multiple averages, including the Dow Jones Industrial average of 30 biggest companies. Only one — General Electric — remains on the list.

In their day, the Dow averages were an innovation that financial analysts relied on to track market trends and develop forecasts. One average tracked transportation companies — mostly railroads; another followed utilities. In the days with the growth of the U.S. economy was based on large manufacturing companies, powered by electricity and moving goods by rail, the Dow averages provided a comprehensive overview of health of the U.S. stock market.

Today, the Dow Jones Industrial average is something of a relic — “industrial” activity like steel and auto manufacturing now makes up a much smaller portion of economic activity and stock market growth. To keep up with the times, the keepers of the DJIA have replaced heavy industry with companies that better represent the overall economy. But while 30 stocks represented a reasonable portion of the hundreds of stocks traded in 1900, the numbers of companies with public shares is now measured in the thousands. No matter which companies are included, the Dow is only a snapshot of a relatively small corner of the overall market.

One of the advantages of a price-weighted average is that it’s (usually) pretty easy to calculate. You just take the closing prices of stocks in the index, add them up and divide by the number of stocks on the list. But, over time, as stocks split or get replaced, things got a little more complicated. To make the math work, you have to add up the prices of those 30 stocks and then use a special devisor that takes these changes into account. Today, instead of dividing by 30, you have to divide by a number less than one (currently  0.123017848 to be precise.) Because dividing by less than one makes a number bigger, not smaller, the current DJIA is a huge multiple of the sum of the closing prices of the 30 stocks that make up the average.

Other market indices, like the Standard and Poor’s 500, give a more complete picture. But the Dow is the oldest, with the longest set of historical data to relay on for market analysis. Because “the Dow” over the years has become shorthand for the stock market, most people still rely on it as the basic benchmark for the market performance.

The durability of the DJIA may also rest, in part, on a decision in 1882 by founders Charles Dow and Edward Jones to keep their company’s name short. To the great relief of headline writers and broadcasters since then, the name of a third partner, Charles Bergstresser was not included.
 

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