Why Most Professionals Prefer the Wilshire 5000 as a Better Indicator of the U.S. Stock Market
The difference between the Dow Jones Industrial Average (DJIA) and the Wilshire 5000 Index is significant and crucial for professionals when it comes to understanding and predicting the broader performance of the stock market. In this article, we will explore why most professionals consider the Wilshire 5000 a better tool for measuring the overall performance of the U.S. stock market.
Understanding the Dow Jones Industrial Average (DJIA)
The Dow Jones Industrial Average is a widely recognized stock market index that tracks the performance of 30 large, publicly traded companies in the United States. The DJIA is a price-weighted index, meaning that the price of the stocks, rather than market capitalization, determines the index value. The companies included in the DJIA are chosen for their significance in the economy and are often major conglomerates or blue-chip companies.
However, the DJIA is subject to a few limitations. One major limitation is its simple average calculation method, which multiplies the average price of the 30 components by a factor that ensures the index remains unchanged when the number of component companies changes. This methodology can result in an index that does not accurately reflect the overall performance of the broader market.
Introducing the Wilshire 5000 Index
On the other hand, the Wilshire 5000 is a market-cap weighted index that includes every actively traded stock in the United States. While there are fewer than 5,000 actively traded stocks, the Wilshire 5000 provides a comprehensive view of the overall market. Unlike the DJIA, which is limited to just 30 companies, the Wilshire 5000 covers a vast range of companies, providing a more accurate reflection of the stock market's performance.
Why Professionals Prefer the Wilshire 5000
Market-Cap Weighting
One of the key reasons professionals prefer the Wilshire 5000 is its use of market-cap weighting. In a market-cap weighted index, the weight of each company in the index is determined by its market capitalization, which is the total value of its outstanding shares. Companies with larger market caps have a greater influence on the index, reflecting their size and market significance.
Market-cap weighting is considered more logical and representative than the simpler price-weighting of the DJIA. When a stock's price changes significantly, its weight in the price-weighted index changes, which can distort the overall performance of the index. In contrast, market-cap weighting ensures that the relative importance of each company remains consistent, regardless of small changes in stock prices.
Broad Coverage
The Wilshire 5000 covers a much broader range of stocks than the DJIA. While the DJIA focuses on just 30 companies, the Wilshire 5000 includes almost all publicly traded stocks in the United States. This wide range of inclusion means that the Wilshire 5000 can more accurately reflect the performance of the entire market, rather than just a select few industries or companies.
Historical Performance Insights
Historical data supports the superiority of the Wilshire 5000 in terms of representing the overall market performance. By including a larger and more diverse set of stocks, the Wilshire 5000 provides a more stable and reliable measure of the market's health. The index has consistently tracked the overall market performance more accurately than the DJIA, making it a preferred tool for investors and financial professionals.
Conclusion
In conclusion, the Wilshire 5000 is a more comprehensive and accurate indicator of the U.S. stock market's performance compared to the Dow Jones Industrial Average. Its use of market-cap weighting and broad coverage makes it a better tool for understanding and predicting the overall market trends. For professionals and investors seeking a more reliable and representative measure of the stock market, the Wilshire 5000 is the preferred choice.