Everyday the financial “news” tells us the status of the S&P 500, the Dow Jones Industrial Average and the Nasdaq Composite because these are the three most followed indexes by media and investors.
I’ve found through the years that many people have no idea what an index is or specifically what these three indexes represent.
Today I’m going to give you a Cliffs Notes version of what an index is as it relates to the stock market and a brief explanation of the three major indexes.
What is a market index?
Simply put, a market index tracks the performance of a certain group of stocks, bonds or other investments.
These investments are often grouped around a particular industry segment.
The S&P 500 Index tracks the performance of the top 500 companies in the United States
The Dow Jones Industrial Average Index tracks the top 30 companies in the United States
The Nasdaq Composite Index tracks approximately 3,300 technology stocks
The stocks in each index will be ranked based on market capitalization which is a fancy term that means the overall value of the company which is calculated by the total number of shares available multiplied by the current price of its stock.
Company X has 100 shares of stock available at a current market price of $10 per share. This would make their market capitalization $1000.
Even though each index is different, many of the same companies will be represented across all three of these indexes.
We know if the Dow Jones Industrial Average Index tracks the top 30 companies then those same 30 companies will also be included in the S&P 500.
We also know that if a technology company is big enough it will be listed in all three indexes. Think Apple and Microsoft.
There are literally thousands of different indexes that are tracked in the stock market, but like I mentioned earlier most investors only pay attention to the S&P 500, the Dow Jones Industrial Average and the Nasdaq Composite.
These three indexes give us a very good indication of how the market is performing overall.
The major 3 indexes briefly explained
1. The S&P 500
The Standard & Poor's 500 Index, commonly known as the S&P 500, is an index with 500 of the top companies in the U.S. Stocks chosen by market capitalization. The S&P 500 Index represents approximately 80% of the total value of the U.S. stock market and provides a gauge of the whole U.S. market.
2. The Dow Jones Industrial Average
The Dow Jones Industrial Average (DJIA) includes the stocks of 30 of the largest and most influential companies in the United States. The index is known for listing the U.S. market's best blue-chip companies with regularly consistent dividends.
The DJIA represents about 25% of the value of the U.S. stock market.
3. The Nasdaq Composite Index
The Nasdaq Composite Index is a market-capitalization-weighted index of all the technology stocks traded on the Nasdaq stock exchange and includes companies based outside the United States.
This index covers several subsectors across the tech market, including software, biotech, and semiconductors.
Although the Nasdaq carries a large portion of technology stocks, it does include securities from the financial, industrial, insurance, and transportation sectors. The Nasdaq Composite includes large and small firms, but unlike the Dow and the S&P 500, it also holds many speculative companies with small market capitalizations. The movement of this index generally indicates the performance of the technology industry and investors' attitudes toward speculative stocks.
What does this mean to your portfolio?
Maybe a lot and maybe nothing at all.
If you own single stocks or a mutual fund containing stocks tracked by these 3 indexes then it may give you an idea of how your portfolio is performing.
If you own single stocks or mutual funds NOT tracked by these three indexes then these index numbers that are reported every day literally mean nothing to your portfolio.
Indexes play an important part in the overall analysis of the U.S. equity market. Indexes and their movements provide insight into the economy, investor sentiment, and trends for investing diversification.
But remember these three indexes are only three of literally thousands of indexes tracked daily. They are just the only three that the media reports on a daily basis.
Please remember that your portfolio's job is not to beat an index, it’s to accomplish your retirement goals.
Hope this sheds some light on the main three stock market indexes.
You need a plan
At 80/20 Financial Services, we are retirement planners. We specialize in retirement planning for electric cooperative employees within 5 years of retirement or already retired.
We believe a goal of retiring - without a plan to increase your income during retirement- is simply a plan to run out of money. Retirement planning is a strategy to maintain and increase that dollar amount over time.
If you're age 50 or over and still in the accumulation phase (pre-retirement) we can help you figure out where you need to go and how to get there. If you are retired or nearing retirement, we can create a plan which will outpace inflation and increase your income over time. The consultation is free and without obligation. Contact us to set up a consultation.
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We specialize in helping electric cooperative employees create their retirement income and investment plans. Retirement can last 20-30 years. You need a plan!
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