An Overview of Three Major U.S. Stock Indices

by | Sep 14, 2023 | Research

The first time you heard someone say, “the stock market is up today,” you probably wondered what they meant. Could they really know how all the stocks in the world were faring? Probably not. Instead, when someone mentions “the stock market” in this context, they are usually referring to a stock index.

A stock index provides a standardized way to measure the performance of a basket of stocks. The collection of stocks could represent the entire stock market or a particular sector. If you understand how a stock index works, you can use it to guide your investing decisions.

What is a stock index?

A stock index is a collection of stocks that is meant to represent all, or a particular segment of, companies in a market. You can think about this in the same way a sample group is used in statistics to draw conclusions about a total population.

Company size, industry, region, and even history of dividend payments ­are some of the criteria that can be used to create a stock index. Once an index is available to the public, investors, economists, and policy makers can use this single data point to infer details about the performance of the group.

The number of shares of each stock is not usually the same in an index. Instead, a weighting method is often implemented to keep the value of the index consistent with the performance of the underlying securities. Without weighting, events that change the value of the stock without impacting market cap – such as a stock split – could break the index.

Major U.S. Stock Indices

In the U.S., there are thousands of stock indices. However, the Dow Jones Industrial Average, S&P 500, and Nasdaq Composite are referenced most frequently. The chart below summarizes the key features of these three indices.

A chart showing a summary of the 3 key stock indices. Dow Jones: founded 1896, includes 30 U.S. stocks, tracks stocks in the Blue-Chip sector. S&P 500: founded 1957, includes 500 U.S. stocks, tracks U.S. stocks. Nasdaq: founded 1971, includes 3,000+ U.S. and international stocks, tracks stocks in the tech sector.

The Dow Jones Industrial Average

The Dow Jones Industrial Average [DOW] is the oldest of the three indices discussed in this article. It was formed in 1896 by Charles Dow – founder of the Wall Street Journal – and his business partner Edward Jones.

Initially, the DOW tracked the performance of 12 stocks in the industrial sector. Later, it was expanded to include more stocks in a broader range of industries. Today, the DOW tracks 30 stocks which represent about a quarter of the total value of the U.S. stock market.

The companies included in the DOW are generally “Blue Chip” stocks – large, well-established companies. These stocks are weighted based on price, with higher priced stocks representing a larger share of the index.

As the chart below shows, the DOW includes stocks in nearly every major industry, though it is more heavily weighted to the Financial, Health Care, and Information Technology sectors.

A donut chart showing the sector breakdown of the Dow Jones Industrial Average – Financials: 20.3%, Health Care: 18.8%, Information Technology: 18.3%, Industrials: 15.0%, Consumer Discretionary: 13.7%, Consumer Staples: 7.6%, Energy: 3.0%, Communication Services: 2.3%, Materials: 1.0%.

The Standard & Poor’s 500 Index

Standard Statistics released its first stock index in 1923. After merging with Poor’s Publishing in 1929, the new company – Standard & Poor’s – continued providing index information and stock rating services.

Standard & Poor’s created their S&P 500 index in 1957. At that time, it was the only computer-generated stock index. Today, this index remains one of the most trusted sources of U.S. stock information.

The S&P 500 includes the 500 largest publicly traded companies by market cap in the United States. As such, it tracks about 80% of the total value of U.S. stocks. This index is also weighted based on market cap – meaning that larger companies represent a larger portion of the index. Due to its vast coverage, the S&P 500 is often used as a proxy for all U.S. stocks.

As shown by the chart below, the S&P 500 is more evenly weighted between stock sectors than the DOW. However, Information Technology, Health Care, and Financials still make up the largest portions of the index.

A donut chart showing the sector breakdown of the S&P 500. Information Technology: 28.1%, Health Care: 13.1%, Financials: 12.6%, Consumer Discretionary: 10.6%, Communication Services: 8.7%, Industrials: 8.5%, Consumer Staples: 6.6%, Energy: 4.3%, Utilities: 2.6%, Materials: 2.5%, Real Estate: 2.5%.

The Nasdaq Composite Index

The Nasdaq Composite Index is both the newest and largest of the three indices discussed in this article. It was launched in 1971 and includes all stocks traded on the Nasdaq exchange – both U.S. and international. In total, the index tracks more than 3,000 stocks.

Whereas the DOW and S&P 500 are limited to large companies, the Nasdaq Composite can include companies of any size. In fact, the only requirement for a stock to be included in the index is that it is traded on the Nasdaq exchange. Like the S&P 500, the stocks in the index are weighted by market capitalization. Due to the nature and history of the Nasdaq stock exchange, companies in the Technology sector make up more than half of the index. This large concentration of technology stocks makes the Nasdaq Composite a common gauge for the performance of that sector.

The chart below shows the sector breakdown of the Nasdaq Composite Index. As you can see, the index is heavily weighted to Technology but includes many other major industries as well.

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A donut chart showing the sector breakdown of the Nasdaq Composite Index. Technology: 55%, Consumer Discretionary: 18.4%, Health Care: 8.0%, Industrials: 4.7%, Financials: 4.3%, Telecommunications: 3.4%, Consumer Staples: 2.9%, Energy: 1.0%, Real Estate: 1.0%, Utilities: 0.9%, Basic Materials: 0.4%.

The Value of a Stock Index for Investors

As previously stated, a stock index can help you gauge the movements of a group of companies. This information is particularly valuable when you use a stock index as a benchmark – a yardstick by which to judge other investments.

One way to use an index as a benchmark is to compare the risk of an investment to the risk of an index. You can do this through a calculation called Beta which seeks to compare an investment’s risk to the overall market – commonly represented by the S&P 500.

You can also judge the performance of an investment using a stock index as a benchmark. For example, you can compare the annual returns of a technology focused mutual fund to the Nasdaq Composite Index to put the mutual fund’s return in perspective.

In addition to benchmarking, stock indices are used to create index mutual funds and exchange traded funds [ETFs]. These are collections of securities that seek to mirror a particular index thereby providing broad exposure to a group of stocks with low overhead costs.

With thousands of stock indices, index funds, and ETFs, it can be challenging to find the one that meets your needs. An experienced wealth manager can help you find the right index to use as a benchmark, compare the risk and performance of different investments, and even help you create a portfolio to reach your investing goals.

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Article Topics: Investment Advice | Stocks