Stock Market Indices
Those long columns of abbreviations and numbers in the financial section of the newspaper might seem mysterious, but we’re about to shed some light on them by walking you through the basics of stock market indices. Keep reading to learn about the stock market index, Dow Jones, S&P 500, and more.
What Is the Stock Market Index?
A stock market index is a tool used by investors to describe the market by categorizing stocks into groups and measuring their performance. Examples of stock market indices are the Dow Jones Industrial Average (DJIA), the S&P 500, and the small-company index, the Russell 2000. We’ll get into more depth about the Dow Jones Index and the S&P 500 Index before giving you some strategic advice for your own investments.
Dow Jones Index
The Dow Jones Index was created by partners Charles Dow and Edward Jones in 1896. The Dow Jones Index is a market-capitalized index that currently consists of the 30 largest U.S.-based companies. Each of those companies has a particular weighting within the stock market index. Price changes in the stocks of the 30 companies move the price of the Dow Jones Index – that is, it’s a price-weighted index. So if a single company in the Dow 30 has a bad day, its drop in price can drag down the whole index.
Dow 30 Companies
Here’s what the Dow 30 looks like today:
You might notice that the companies in the current Dow 30, like Apple, Cisco Systems, and Visa, have very little to do with traditional heavy industry. However, they’re a huge part of the modern American economy of 2019. Also, the Dow 30 companies are all represented in the S&P 500 Index – you’ll see why shortly.
S&P 500 Index
The S&P 500 Index is probably the most widely followed of all market indices because it’s considered the best representation of the U.S. stock market. As the name suggests, it consists of the 500 largest U.S.-based companies, which is why you’ll find all of the Dow 30 companies in the S&P 500 Index as well. The weighting of the companies within the S&P 500 Index is by market capitalization. That means the impact of the individual stock price on the overall index is proportionate to the company size relative to the total market capitalization of the index. So the very largest companies, with market caps in the neighborhood of $1 trillion, will have a far greater impact on the index than a company with a market cap of $25 billion – still large, but only about a quarter the size of the giants.
S&P 150 Companies
Here’s a list of the top 150 companies in the current S&P 500:
Stock Market Investing Strategy
How can this knowledge help you decide where to put your money? First, consider the stock market indices’ differences in weighting. Indices weighted by market capitalization are heavily influenced by the top dozen or so companies, which can account for around 40 percent of the index’s moves. Being so dependent on a handful of companies isn’t wise – even the best-established, highest-performing companies aren’t guaranteed to stay that way.
To diversify your investment and reduce your risk, consider an equal-weighted strategy, which disregards company size so the weighting is spread equally. Instead of relying on the top ten holdings of the stock market index, many of which are technology companies – meaning your portfolio isn’t very diversified – an equal-weighted strategy distributes your investment among a larger number of companies. That diversification cuts your risk and makes for potentially better returns over the long haul.
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