Top Three Stock Market Indices to Know
In our first Investing piece, we briefly mentioned the S&P 500, an investment index. Here, we are going to dive deeper into the top three stock market indices in the United States to know: S&P 500, Dow Jones Industrial Average, and the NASDAQ Composite.
Maybe you have heard the names of some of these floating around in the news but may not know that they are one of the top indicators of economic success or failure, along with Gross Domestic Product (GDP), oil prices, inflation, and employment, to name a few.
This article will explain how you can think about these three indices when thinking about U.S. economic health and your own personal investments. Let's dive into the basics below!
First Things First... What is an Index?
An index is a group of companies, chosen based on certain criteria, that are pooled together. The calculation that goes into that index number varies index by index (including the number of companies that are pooled together), but at the core of it, the index value is an average of all of the companies in it.
The value of an index fluctuates up and down constantly, just as the value does for an individual stock, over time. You might often hear on the news or read that the stock market is "up 20 points" or "down 20 points". To put it simply, points = price change.
The price change is calculated as follows (you may also remember this calculation from high school math days 😬):
Percent Increase: [New Price - Old Price] / Old Price
Percent Decrease: [Old Price - New Price] / Old Price
For example, if the S&P 500 was at 3,500 points at the end of the day yesterday and then increased to 3,600 points at the end of the day today, that would be a 100 point increase, which is equal to a 0.29 percent increase.
Top U.S. Stock Market Indices and What They Measure 📈
The Standard & Poor's (S&P 500) index is the most commonly followed stock market index in the world, consisting of the average of the 500 largest publicly-traded companies headquartered in the United States.
publicly-traded → companies that are actually placed on the stock market where individuals like yourself can buy/sell shares of stock, as opposed to private companies that are not on the stock market like Instagram or WhatsApp.
largest → refers back to market-cap, which we touched on here if you need a refresher!
The top five companies in the S&P 500 are all companies that you are probably familiar with already:
To put things into perspective, the S&P 500 has been trending at an average of ~3,100 points for most of 2020, but in March we saw its lowest dip 📉 down to ~2,200 points with the onset of Coronavirus in the United States. That is 55% lower than the stock's price on October 23rd, 2020:
The reason that many people follow the S&P 500 so carefully is that it is an excellent indication of the stock market as a whole. The S&P 500 market-cap makes up 80% of all publicly-traded companies in the United States. That's a pretty large amount!
There are 11 sectors (industries) that all make up the S&P 500. Each of these 11 industries is made up of a group of companies that are related in their job function; for example, Johnson & Johnson and Pfizer both fall in the Health Care industry. Technology companies lead the way, representing approximately 28% of the S&P 500, which makes sense given how much growth we have seen in that area over the last few years (I'm looking at you, Jeff Bezos and Mark Zuckerberg 👀). On the other hand, Energy companies (oil and gas, renewable energy, and coal) represent only about 2% of the S&P 500.
* Note: These companies are not only some of the largest, but also some of the most influential in their industry. Take Visa, for example, one of the top 10 companies in the S&P 500; Visa revolutionized the e-commerce industry by creating "Click to Pay" allowing customers who use a Visa credit/debit card to no longer have to enter 16-digit primary account numbers, look up passwords or fill out long forms when checking out online.
Dow Jones Industrial Average
The Dow Jones Industrial Average (DJIA), the second oldest U.S. stock index in the world, contains 30 hand-picked large publicly-traded companies in the United States. The 30 stocks are exclusively hand-picked by two experts at The Wall Street Journal and three experts at S&P Global (Dow Jones parent company). The DJIA has a more narrow focus of the United States stock market than the S&P 500; DJIA focuses purely on blue-chip companies (well-known, well-established, and well-funded).
The top five companies in the Dow Jones include:
The Dow is constantly evolving as other indices are as well. The Dow used to contain a large portion of manufacturing companies, but over time has evolved towards the inclusion of Information Technology (Salesforce.com) and Health Care (UnitedHealth Group and Amgen).
These hand-picked companies are in line with current and future economic trends, giving it importance as one of the top three followed stock market indices in the United States.
While the S&P 500 covers 11 sectors, the Dow Jones covers only 9 of these, excluding transportation and utilities from their index. The reason why the DJIA excludes these two industries is because the transportation and utilities industries each have their own indices. 🤯
The NASDAQ Composite has over 2,500+ publicly-traded companies on its exchange with a heavy weight towards technology companies. Compared to the S&P 500 or Dow Jones, the NASDAQ is unique in that it has companies that are both international and U.S. based. There is no market-cap requirement; a stock simply has to be exclusively listed on the NASDAQ Stock Exchange (companies must meet one of four financial standards and certain cash requirements to be listed on the NASDAQ Stock Exchange).
The top five companies in the NASDAQ are the same as the S&P 500. This is because the NASDAQ Composite index includes all the companies that are listed on the NASDAQ stock exchange which includes the S&P 500 and Dow Jones Industrial Average. Here are five other top stocks in the NASDAQ Composite:
The NASDAQ Composite is often seen as a good indication of how the technology industry is doing globally; approximately 50% of the index is made up of technology companies.
The NASDAQ covers 10 sectors, excluding Real Estate. Because the NASDAQ has an inclination and greater concentration in technology the risk for this index is higher than for the S&P 500 or Dow Jones. If something were to go wrong with the tech industry, there would be a significant decline in the NASDAQ index 📉. Something to take into consideration! Always make sure to think about your risk appetite.
Below you can see the industry breakdown, weight, and also the number of stocks that are in each specific industry of the NASDAQ composite:
Note: When NASDAQ was first established, it was the first electronic stock exchange in the world, which helped it attract new technology companies. Before the electronic stock exchange came into play, everything was done by paper, which was time consuming and led to human error at times.
To bring everything together, here's a summary table of the top three indices that you can refer back to anytime:
How Can I Invest Directly in an Index?
The easiest way to invest in an index is to buy an "index fund". An index fund is an ETF (exchange-traded fund) or mutual fund that follows one index closely. An index fund is set up to have the same weightings and companies in it as the index that it follows.
The Vanguard 500 Index Fund (VOO) is one ETF that follows the S&P 500. If we look at how the fund has done over the past 10 years, we see that it closely mirrors the S&P 500!
Each index has one or more index funds that follow it closely that you can choose to invest in 🤑. In addition to VOO, the SPDR S&P 500 ETF (SPY) is another popular ETF that follows the S&P 500.
The closest fund to track the Dow Jones is the Dow Jones Industrial Average ETF (DIA).
Lastly, Fidelity offers a mutual fund and an ETF that tracks the NASDAQ Composite: Fidelity NASDAQ Composite Index Fund (FNCMX) and NASDAQ Composite Index ETF (ONEQ) both with no minimum investment amount! If you want to track just the top 100 companies in the NASDAQ, consider the Invesco ETF (QQQ).
What Does it Mean When the Stock Market is Up or Down? 🤔
The stock market is a key indicator of an economy's success (or failure). When the 'stock market' is spoken about broadly, it generally refers back to these top three indices! That's how important they are.
When the market is "up" 📈that's a positive sign of a growing and healthy economy. The price of stocks has increased from a previous point in time.
When the market is "down" 📉that's a negative sign of a slowing and declining economy. The price of stocks has decreased from a previous point in time.
Remember though, that this is all relative. Each index is calculated slightly differently and operates differently, so it's important to look at how the index performed historically, such as year-to-date (YTD):
The stock market is in constant fluctuation and absolutely no one can predict precisely where it will be tomorrow, a week from now, or a month from now!
⭐ What's most important is to understand why a change is happening and how it can impact how you invest.
The reason for the market going up or down could be anything from internal factors at the company (sales, hiring/layoffs, debt) to external factors (COVID-19, competition, politics). Here is where the news comes into play; it helps us digest exactly what is going on with the market and/or specific companies in real-time. It helps us better understand the companies we have chosen to invest in or are choosing to invest our own money in.
Action Items ✅
Consider investing in an index fund; a good starting place is an index fund that follows one of the top three indices that we talked about today. We mentioned a few to help you get started in the "How Can I Invest I Directly in an Index?" section including the Vanguard 500 Index ETF (VOO) which tracks the S&P 500, the Dow Jones Industrial Average ETF (DIA) which tracks the Dow Jones Industrial Average, and Fidelity NASDAQ Composite Index Fund (FNCMX) which tracks the NASDAQ Composite.
Research one index outside the top three that we discussed. Here are some names to jumpstart your search: Dow Jones Transportation Average, Dow Jones Utility Average, Russell 2000 (smallest U.S. publicly-traded companies).
Stay up-to-date on the latest financial trends through the news, instagram, books, or the Internet. Bloomberg Businessweek, CNN Money, and MarketWatch are excellent free starting places. The knowledge will help you make better decisions about why a change is happening in a specific company or in the stock market and in turn it can impact how you decide to invest.
We know that was a lot of information, but hopefully, you were able to learn a little bit about the top three indices, investing in an index, and how the stock market relates to the economy! All of this information can help you make better, stronger, and more confident decisions when you invest.
Disclaimer: The content on Young, Not Broke is for informational and educational purposes only and should not be construed as professional financial advice. Should you need such advice, consult a licensed financial or tax advisor.