Hi everyone, it’s Virtual Dan! You may have heard the news that the Dow Jones Industrial Average is going to be reshuffling its deck on August 31, 2020. That’s right, I’ve spoken quite a bit about stock market indexes trying to help everyday folks understand some of this Wall Street jargon so you know what you are investing in.
Let’s start with a brief recap of what the Dow Jones Industrial Average index is and how it’s constructed…
Two business partners created the Dow Jones Industrial Average in 1896; they were Charles Dow and Edward Jones. They created the Dow Jones Industrial Average to make it easier to understand the movement of the stock market over any particular period of time.
So how is the Dow constructed today? It’s a price-weighted index – which is quite a bit different than the S&P 500 and many other indexes that are market cap weighted.
Price weighted means that member companies are weighted by stock price. The higher the price per share, the higher percentage weighting to the movement of the index.
Market cap weighted means that member companies are weighted by market capitalization (price x number of shares). The higher the total market capitalization, the higher percentage weighting to the movement of the index.
Understanding how a price-weighted stock index works is important because it’s exactly why next week’s reshuffling of the Dow Jones Industrial Average is happening in the first place.