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Which index does the best job of tracking the market: the Dow Jones Industrial Average, S&P 500 or the Nasdaq? Thanks, L.G.
Like network newscasts, all three indices offer their own version of the same subject. In this case, however, it's the composition and weighting of the stocks inside the respective indices that cause the stories to diverge.
From an investor's standpoint, it's important to know the characteristics of each index before following one blindly. So here is a quick breakdown of what investors should understand about the three benchmarks.
Usually when you hear folks refer to "the market" in casual conversation or on the evening news, they are referring to the Dow Jones Industrial Average. The DJIA consists of 30 public companies selected by the editors of
The Wall Street Journal
. The index, created by
co-founder Charles Dow, was first published in May 1896.
Dow's original index contained 12 stocks, of which only
remains. The other members have dissolved, merged or morphed beyond recognition over the past century. (Sorry, U.S. Leather and United States Rubber, but you had your day in the sun.)
And despite the use of "industrials" in the title, not all of today's current DJIA members would be considered heavy industry by Wall Street standards.
, for instance, hardly fit into the "smokestack" category of industry.
The most recent additions to the venerable index have continued the trend toward fewer manufacturers and more service- and technology-based companies, mirroring the overall U.S. economy.
Goodyear Tire & Rubber
were replaced in the DJIA by
and SBC Communications, which is now
. (Intel and Microsoft, by the way, became the first two Dow components listed on the
rather than the
, the former AT&T, and
were bounced in favor of
The Dow stood at 40.94 when it was first published prior to the turn of the 19th century. It didn't crack the 1,000 mark until 1972. In 1995, the DJIA broke 5,000, and in 1999 it busted through the 11,000 mark.
The Dow hit an all-time high of 11,722.98 in January 2000, before the tech bubble imploded. The Dow dropped below 7,300 in 2002 before rallying back past 11,000 in 2006.
The biggest criticism of the Dow Jones index, aside from it being narrowly based with just 30 stocks, is the fact that it's a price-weighted average. That means that high-priced stocks, like
at its current perch near $83, have more sway over the average than low-priced members like GE, which trades around $34 a share.
One way investors can purchase shares of the DJIA without buying each stock individually is via the
exchange-traded fund, also known as the Diamonds.
The S&P 500 avoids the criticism often thrown at the Dow because it is weighted by float (the share price times the company's public shares available to trade), not price. In other words, a company's size in terms of market value counts. Movement in the price of companies whose market valuation is larger will affect the index more than companies with a lesser overall value.
In terms of components, the S&P 500 is composed of 500 of the largest U.S. public companies, as ranked by their size. Nevertheless, the list isn't solely compiled according to market capitalization. Standard & Poor's, a subsidiary of publishing giant
, also chooses the companies that represent various industries. That diversification makes the S&P not only a reliable benchmark for U.S. stocks, but for the overall economy as well.
The S&P 500 shouldn't be confused with the Fortune 500, which lists the 500 largest public companies in the country based on gross revenue.
Investors looking to invest in the S&P 500 can either purchase a mutual fund tracking the index or an ETF called the
Standard & Poor's Depositary Receipts
, also known as "Spiders."
In January 1995, the S&P 500 was less than 460. It hit an all-time high in March 2000, when it broke through 1,550. Most recently, the index has hovered around 1,260.
The Nasdaq is an electronic stock exchange founded in 1971 by the National Association of Securities Dealers. It's now a public company known as the Nasdaq Stock Market, trading under the ticker NDAQ.
The Nasdaq lists more companies (about 3,300) and, on average, trades more shares per day than any other U.S. market. Due to its less-stringent listing qualifications than the NYSE, the Nasdaq market has historically attracted technology and biotech companies. That's why the exchange -- and its composite index -- has a reputation for volatility.
The Nasdaq Composite index measures all domestic and foreign common stocks listed on the Nasdaq stock market. The index is market-value weighted, which once again means that each company's shares affect the index in proportion to its market value. The market value, meaning the last sale price multiplied by total shares outstanding (not the float, or publicly available shares, like the S&P 500), is calculated throughout the trading day. But the Nasdaq Composite does have its limits in serving as a barometer for the overall market because it excludes some of the biggest companies in the world, which may trade on the NYSE.
The Nasdaq index eclipsed the 1,000 mark for the first time in July 1995. It peaked at 5132.52 in March 2000, right before the collapse of the technology bubble.
The most popular way traders invest in the Nasdaq is through buying shares of the
Nasdaq 100 Trust
. The particular subset includes 100 of the largest domestic and international nonfinancial companies listed on the Nasdaq based on market capitalization.