TAILIEUCHUNG - The Dow Jones Industrial Average: The Impact of Fixing Its Flaws

Because private fund advertisements will reach all investors, there is a tremendous potential for investor confusion. The fact that sales are limited to accredited investors offers no protection in this regard, because it can only occur after the fact. To address this problem, it is critical that the Commission require all advertisements for private funds to include a clear, conspicuous, and prominent legend that the advertisement is not an offer, that investments are restricted to investors who qualify, and that the advertised fund is not registered with the Commission and should not be confused with mutual funds, closed-end funds,. | The Dow Jones Industrial Average The Impact of Fixing Its Flaws John B. Shoven Stanford University and NBER Clemens Sialm Stanford University February 28 2000 Abstract The Dow Jones Industrial Average is a flawed index. The index uses price weights instead of conceptually superior market valuation weights the companies included in the index are not chosen systematically and are not very representative of the . market and the index ignores returns from dividends. This paper shows that alternative stock price indices which use superior weighting methods and a more systematic inclusion criterion perform very similarly to the Dow Jones Industrial Average. However ignoring dividends underestimates the long-run returns earned by stock market investors dramatically. If Dow Jones Co. had included dividend returns in the DJIA when it was reformed in 1928 the index would be over 250 000 today. The authors would like to thank Lora Cicconi Olivia Lau and Jay Sheth of Stanford for superb assistance with this research. David Felman Davide Lombardo and Sita Nataraj have given us helpful comments. This work is part of the Finance Program of the Stanford Institute for Economic Policy Research. 1. Introduction The Dow Jones Industrial Average DJIA is the most quoted stock market index in the world. The changes in the index are often perceived to be representative of the entire stock market. This paper discusses whether the performance of the DJIA differs significantly from the performance of better-constructed indices and whether investors make a large mistake in paying attention to this flawed index. Charles Dow one of the founders of Dow Jones Co. which also publishes Barrons and The Wall Street Journal created the first stock market index. He began in 1884 with 11 liquid and highly capitalized stocks most of them railways. On May 26 1896 the Dow Industrial Average was first published. It included all 12 industrial companies listed on the New York Stock Exchange as industrial .

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