With U.S. stock market indexes reaching new highs and round-number milestones, it is time for a refresher on the differences among them.
Although these measurements have become a quick way to gauge what’s going on in markets, they are by no means the whole story. And of course, your investments may or may not track the path of stock indexes, depending on your specific allocation.
Dow Jones Industrial Average
The “Dow” was introduced in May 1896 and along with the Dow Jones Transportation Average and Dow Jones Utility Average, these indexes provided the public with a snapshot of financial market performance.
When it began, the Dow tracked 12 companies, which were representative of the most important industries in the U.S. By 1928, the index included 30 companies, which is still the number that are included in the index.
Although the Dow is the oldest index, it is problematic because of the way it is calculated. The Dow is price-weighted, which means that higher-priced stocks have a larger influence on the index.
For example, Microsoft, which is trading at over $400 per share, is a much more important contributor to the Dow than Verizon, which is trading at $40. Despite its history, the small size of the index, along with its price-weighting methodology, makes the Dow the least efficient way to determine what’s going on in financial markets.
The Standard and Poor’s 500
The “S&P 500” was introduced in March 1957 and was intended to address some of the shortcomings of the Dow. Instead of 30 stocks, the S&P tracks 500 U.S.-based companies, which covers about 80 percent of the overall market.
Additionally, the S&P 500 is weighted based on market capitalization (“market-cap”), which is calculated by multiplying the number of shares outstanding by the current market price. Those companies in the S&P 500 with the highest market cap have the greatest impact on the value of the index.
Nasdaq Composite Index
The National Association of Securities Dealers Automated Quotations (“NASDAQ”) was launched in 1971 as the world’s first electronic stock market.
Eventually, this innovation led to the elimination of physical trading floors, which relied on human beings to transact buy and sell orders. (The New York Stock Exchange trading floor is now just a backdrop for financial media.)
Until the dot-com boom of the 1990s, the Nasdaq exchange was a place where smaller companies listed their shares, until they became large enough to gain a spot on the more-established New York Stock Exchange.
The current Nasdaq Composite Index includes more than 2,500 stocks and like the S&P 500, is market-cap weighted. More than half of the index consists of the technology sector, which is why it has become shorthand for “tech” when quoted alongside the Dow and the S&P 500.
Other indexes
Although the Dow, the S&P 500 and the NASDAQ are the three most-cited and watched stock market indexes, they are by no means the only ones.
You can find specific sector indexes (energy, materials, health care), size-indexes (mega-cap, mid-cap, small-cap), as well as comprehensive indexes (FT Wilshire 5000) and those that are calculated based on equal weight, where each company is allocated a fixed equal weight in the index and therefore have the same impact on index performance.
Sometimes the investment world creates an acronym or term to describe trends. Today, seven mega-cap companies have dominated financial market discussions.
The so-called “Magnificent Seven” (“ Mag 7”) include Apple, Alphabet, Microsoft, Amazon, Meta, Tesla and Nvidia. In 2023, the Mag 7 logged an impressive average return of 111%, compared to a 24% return for the broader S&P 500. As a result, they spawned their own index which tracks their movements.
Jill Schlesinger, CFP, is a CBS News business analyst. A former options trader and CIO of an investment advisory firm, she welcomes comments and questions at [email protected]. Check her website at www.jillonmoney.com.