The first index we’ll look at is the Dow Jones Industrial Average (DJIA). The DJIA is one of the oldest, most well-known and most frequently used indices in the world. It includes the stocks of 30 of the largest companies in the United States like Nike, Apple, Visa and McDonald’s. The DJIA is what’s known as a price-weighted index.
A price-weighted index is one in which each stock influences the index in proportion to its price per share. Adding the price of each stock in the index and dividing by the total number of stocks determines the index’s value. A stock with a higher price will be given more weight than a stock with a lower price and, therefore, will have a greater impact in the index’s performance.
Another index you might hear about is the Standard & Poor’s 500 Index (known commonly as the S&P 500). The S&P 500 is made up of 500 of the most widely traded stocks in the U.S.; it represents about 80% of the total value of U.S. stock markets. The S&P 500 index includes companies in a variety of sectors, including energy, industrials, information technology, healthcare, financials, and consumer staples. In general, the S&P 500 index is widely considered a reliable indication of movement in the U.S. marketplace as a whole.
Because the S&P 500 index is market-weighted (also referred to as capitalization-weighted), every stock in the index is represented in proportion to its total market capitalization. Market capitalization is calculated by multiplying the number of outstanding shares of stock, by the current price of one share. I If the total market value of all 500 companies in the S&P 500 drops by 10%, the value of the index also drops by 10%.
A 10% movement in all stocks in the DJIA, by contrast, would not necessarily cause a 10% change in the index. Many people consider the market weighting used in the S&P 500 to be a better measure of the market’s movement because portfolios are more easily compared when changes are measured in percentages rather than dollar amounts.
The last index we’ll cover is the Nasdaq Composite Index. It is a market-capitalization-weighted index of the stocks that trade on the Nasdaq stock exchange. This index includes some companies that are not based in the U.S.
Although this index is known for its large portion of technology stocks, the Nasdaq Composite also includes stocks from consumer services, healthcare, and financial among others. The Nasdaq Composite not only includes large companies but also includes smaller and more speculative companies. Consequently, its movement generally indicates the performance of the technology industry as well as investors’ attitudes toward more speculative stocks.
Market indexes will continue to move up and down through the course of your career. As an investor, you cannot control the markets, but you can control your investment selections. Please let us know if you would like to review your investment lineup to ensure your holdings align with your retirement planning goals.
This is not intended to be investment advice. All investments have the risk of financial loss.
S.E.E.D. Planning Group LLC (S.E.E.D.) is a Registered Investment Advisor (RIA) with the SEC. S.E.E.D.’s team provides investment fiduciary and financial planning services to clients. Our fees are disclosed, easy to understand, and not predicated on product sales.