Understanding Stock Market Indexes: A Comprehensive Guide
Stock exchanges like the Nasdaq and the New York Stock Exchange (NYSE) are two of the largest marketplaces to buy and sell stocks. However, they are different from stock market indexes, which track the performance of specific groups of stocks. You’ve probably heard of the S&P 500, the Dow Jones Industrial Average, and the Nasdaq Composite. These influential market indexes focus on different types of stocks. Let’s break down what a stock market index is and look at the three major indexes.
What Is a Stock Index?
Every stock market index is different, but the common thread is that each one tracks the performance of a specific set of stocks. These stocks typically represent a certain sector of the market. That might be:
- Stocks within a specific industry: For example, the Nasdaq Composite is a market index that focuses heavily on tech stocks.
- Stocks with a certain market capitalization (or “market cap”): This is the total value of all of a company’s outstanding stock. Multiplying a company’s stock price by its total outstanding shares will give you its market cap. Large-cap companies are ones that generally have a market value of $10 billion or more. The S&P 500 focuses on large-cap companies.
- Stocks with certain price points: High-priced stocks are the centerpiece of the Dow Jones Industrial Average.
Some investors might be drawn to one market index over another. You can’t put money directly into a market index, but you can invest in index funds. They contain a portfolio of stocks or bonds that follow a specific market index. The fund tracks the index’s performance with the hope of securing similar returns. An exchange-traded fund (ETF) is a popular type of index fund. It’s also possible to invest in indexed mutual funds.
What Is the S&P 500?
The S&P 500 is one of the world’s most well-known stock market indexes. It’s made up of about 500 of the largest, most stable companies in the United States. (Companies that have more than one share class have multiple listings, bringing the total just above 500.) The larger a company’s market cap, the greater its impact on the index. As of July 31, 2023, the following companies are among the top players:
- Apple
- Microsoft
- Amazon
- Tesla
- Meta
- Berkshire Hathaway
- UnitedHealth Group
For the last century, the S&P 500 has produced average annualized returns of around 10%. This market index is often seen as a reflection of the stock market at large.
What Is the Dow Jones Industrial Average?
The Dow, which is shorthand for the Dow Jones Industrial Average, is one of the most influential stock market indexes in the world. It includes 30 stock listings and is price-weighted. While market cap carries the most weight within the S&P 500, stock price has the biggest impact on the Dow. This index covers all industries, excluding utilities and transportation.
The Dow features U.S.-based blue-chip stocks from large, well-known companies that have solid reputations and earnings. At the time of this writing, some of the top companies within the Dow include:
- American Express
- Apple
- Boeing
- Chevron
- Coca-Cola
- Goldman Sachs
- Johnson & Johnson
- McDonald’s
- Microsoft
- Nike
- Walmart
- Walt Disney Company
What Is the Nasdaq Composite?
The Nasdaq Composite follows all of the common stocks listed within the Nasdaq stock market exchange. That includes more than 2,500 international and domestic companies. Like the S&P 500, this stock market index focuses on market capitalization, so large-cap companies carry more weight. The Nasdaq tends to draw a large presence from the tech sector. Below are some tech giants currently in the top 10 spots of the Nasdaq:
- Apple
- Microsoft
- Amazon
- Tesla
- Meta
- Broadcom
- Alphabet (Google’s parent company)
Are Index Funds Risky?
Index funds offer a low-cost way to invest in a wide variety of stocks. Risk is low, especially when compared to picking individual stocks, and they typically provide stable returns over the long term. Index funds can also help diversify your portfolio and spread out investment risk. That’s assuming you’re also invested in other asset classes. Buying individual shares of stocks that are listed on different market indexes would likely be time-consuming, expensive, and risky.
The Bottom Line
Stock market indexes track the performance of different groups of stocks. The S&P 500, Dow Jones Industrial Average, and Nasdaq Composite are perhaps the most followed. They each work a little differently, but index funds allow you to invest in portfolios that are designed to mimic their performance.
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