When you hear news about the stock market moving higher or lower, it's typically shorthand for the performance of the two major U.S. benchmarks: the Dow Jones Industrial Average and the S&P 500.
The Dow dates back to the late 1800s, while the S&P 500 was introduced in the 1950s — and now, they're both managed by the same company, S&P Dow Jones Indices. Today, more than 100 exchange-traded funds (ETFs) are benchmarked to these indexes, which gives investors on and off Wall Street an easy way to track their performance.
While both the S&P 500 and Dow are made up of some of the world's largest companies, there are several key differences between them. And even though these indexes generally move in the same direction on a daily basis, there can be disparities in returns over longer periods of time.
Here's what you need to know about these two indexes.
One of the most significant differences between these two indexes is the number and type of companies included in each. As its name suggests, the S&P 500 is made up of 500 of the largest publicly traded companies, while the Dow is a collection of 30 companies that are selected to represent their respective industries.
Here's how that distinction affects the composition of each index:
- The U.S. large-cap market. The S&P 500 is the primary benchmark for large-cap stocks, or the biggest publicly traded companies listed on U.S. stock exchanges. Market capitalization, or market cap for short, is a measure of a company's value calculated by multiplying its shares by its current stock price. The S&P 500 tracks companies across the 11 major sectors used for classification, from information technology to real estate.
- Blue-chip companies. The Dow average is composed of just 30 stocks that are considered to be blue-chip companies. These well-established entities are selected for inclusion in the index because they're leaders in their respective industries, and their lines of business generally are relatively stable. The Dow tracks companies in just nine sectors. (None of the current members is in the real estate or utilities industries.)
Video by David Fang
A second big difference between the S&P 500 and the Dow average is how each index is calculated. In both cases, some stocks will have a greater influence on each index's performance.
Here's what that means:
- Price-weighted. The Dow is price-weighted, meaning that the value of this index (currently greater than 28,000) is calculated based on the prices of its 30 members. Changes in this index are dictated by the price changes for the individual members, with the companies with higher stock prices having a bigger effect on the Dow's movements. As of December 2019, the highest-priced stock in the Dow (Boeing) is trading for more than $320 per share, whereas the lowest-priced stock (Pfizer) is trading for about $39.
- Market-weighted. The value of the S&P 500 is calculated based on the market capitalization of each of the 500 members. That means the largest companies constitute a larger percentage of the overall index. As with the Dow, the largest companies in the S&P 500 — currently Apple, Microsoft, Google parent Alphabet, Amazon, and Facebook — have the greatest sway over the index's movements on a day-to-day basis.
Video by David Fang
Because of the different compositions of the two indexes and methods for calculation, you may notice that the performance of these benchmarks varies day-to-day or over longer periods of times. While they generally move up and down in tandem, the magnitude of those moves may differ.
During the past decade, for example, the S&P 500 has outperformed the Dow average — but not by much. If you had bought $500 worth of exchange-traded funds (ETFs) that track the performance of these two indexes (and reinvested the dividends), the difference boils down to a difference of less than $30.
While the past decade has seen the S&P 500 do better, it's been a 50-50 split each year of the last 20 years as to which index has outperformed the other. In that time frame, the Dow has risen more than 145%, while the S&P 500 gained 117%.
Because the S&P 500 is larger, it's more likely to be a benchmark for funds that may appear in your 401(k) or with a robo-advisor. That said, both are popular choices for everyday investors because these indexes are designed to track the largest companies and inherently offer diversification because they include companies across a wide variety of industries.
Past returns are not indicative of future performance, so going forward it's smart to pick an investment mix that fits with your goals and risk tolerance. In addition to a buy-and-hold approach, experts generally recommend that you continue adding money to your portfolio regularly. That way you'll potentially buy at times when stock prices are lower, and you have time on your side, which is key for long-term investing success.
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