We talk a lot about investing in the stock market. But what people mean when they refer to the market can vary. I have quite a few clients who talk about the market. I also hear other people mentioning market this or market that, but I’m never sure if they’re referring to the Dow Jones, the S&P 500, or a more abstract concept entirely.
I’d like to take some time to clarify what we mean by the market. In order to do that, I’m going to go back to a recent conversation I had with sustainable finance expert, Mona Naqvi. Here’s what she said when I asked her to explain the S&P 500:
“Let’s take a step back. The market, I would say, is all of us…We are the market as consumers, as business owners, as employees. Together, we sum up the global economy.
The S&P 500 is a benchmark index. It’s a basket of securities — financial products that are tied to companies — that represent a section of the market. In the case of the S&P 500, this is considered to be the single best gauge of the state of the US economy because it reflects, more or less, the 500 or so biggest companies in the US.”
Note: I edited the above quotation slightly for clarity, but you can listen to our full conversation on the podcast.
Of course, the S&P 500 isn’t the only benchmark we use to track stocks or gauge the economy. Many mainstream media outlets prefer to quote the Dow Jones, and those interested in technology stocks might favor the Nasdaq.
Here’s what you need to know about the three major indices, and a little bit about investing in them.
The S&P 500 tends to be the preferred index for financial professionals. Its performance is weighted by market cap, which means the most valuable companies influence the index more heavily. So if the shares of a huge company like Apple surge, it can lift the entire S&P 500 along with it. Similarly, a big drop in Apple’s stock price can pull the whole index down.
Dow Jones Industrial Average
The Dow tracks just 30 stocks, making it one of the most narrow indices in terms of scope. But the 30 stocks are chosen carefully and are intended to represent the broader economy. These companies tend to be very large (large cap, in market terms), and are sometimes referred to as “blue chip” in a nod to the index’s industrial history. The Dow features companies from the retail sector (Walmart, Nike) as well as finance (Goldman Sachs, JP Morgan), pharmaceuticals (Pfizer), media (Disney), autos (General Motors), and more.
The Nasdaq is traditionally thought of as a “tech heavy” index. However, since technology currently drives most companies today, this distinction isn’t as accurate as it once was. There are two ways of tracking the Nasdaq: the Nasdaq Composite Index and the Nasdaq 100. The main difference is that the Nasdaq 100 doesn’t include financial companies, so if there’s a major move in bank stocks, for example, the Nasdaq 100 is somewhat insulated from the move.
The Nasdaq’s focus on tech stocks also exposes it to a number of growth stocks, which can sometimes be more volatile than other indices. This can be either a pro or a con for investors looking for a benchmark, depending on their investing strategy.
Investing in indices
Indices are built to track a group of stocks. In other words, they’re built to reflect the market, and are not securities. However, a number of financial firms have built exchange-traded funds (ETFs) that mirror these indices. These ETFs essentially give investors an opportunity to invest in the market overall. If you buy an ETF that tracks the S&P 500, for example, your shares will increase in value when the market goes up and decrease when it goes down.
If you have any questions about how to invest in the market or which indices you should keep an eye on, set up a meeting and we can discuss.