Every day we hear numbers that evaluate the stock market’s performance, such as the Dow Jones Industrial Average or the NASDAQ Composite Index. There are a myriad of market indices, and it may seem like they are all measuring the same thing. However, each index evaluates the market in a different way.
Dow Jones Industrial Average (DJIA)
While the DJIA is often used to represent how the stock market is performing as a whole, the index is made up of only 30 large company stocks. Despite its name, the index is composed of more than just industrial companies. The index includes long established entities like General Electric and 3M as well as newer firms, such as Apple, Nike and VISA. The components of the index change from time-to-time, but it always includes stocks that are among the largest in the market. However, given that the index represents the performance of a very limited number of stocks, it may not signify what is happening in the broader market. The DJIA’s value is calculated by adding up the price of all 30 stocks and then dividing it by a specific measure created by Dow Jones.
Standard & Poor’s (S&P) 500
Another reading of large company stock performance comes from the S&P 500 index. Many in the financial industry consider this a more accurate measure of broad market performance than the DJIA because it includes a much larger group of stocks. The index is made up of approximately 500 of the largest companies in the U.S. (currently, there are actually 504 stocks in the index1). This is a “capitalization-weighted” index, meaning that price movements among larger stocks will have more impact on the index than price moves among smaller components in the index. However, the S&P 500 does not account for mid-cap or small-cap stocks’ performance.
Companies that trade on a global electronic marketplace first established by the National Association of Securities Dealers (NASD) are included in this index. More than 3,000 common equities are listed on the NASDAQ exchange, including stocks, American depository receipts (ADRs) and real estate investment trusts (REITs). Some companies may be located outside of the U.S. The index’s composition is largely made up of technology companies, so the performance of that industry can greatly influence the index. Like the S&P 500, the NASDAQ Composite is calculated using a market-cap weighting, with the 100 largest stocks accounting for most of its movement.
This index measures the performance of small-cap stocks in the U.S. market across a broad swath of industries. It is made up of the 2,000 smallest stocks in the Russell 3000 Index, which tracks broad U.S. stock market performance. The Russell indexes are maintained by Russell Investments, an investment research and management firm. Stocks in the Russell 2000 index cut across a broad swath of industries.
Morgan Stanley Capital designed the MSCI EAFE index to help U.S. investors understand how overseas stock markets are performing, particularly in developed countries. The index represents the combined returns of large- and mid-cap stocks in 21 countries across Europe, Australasia and the Far East (EAFE), including Great Britain, Germany, France, Japan and Australia2.
A recently developed index that has received growing attention is referred to as the VIX. This is actually a ticker symbol representing the Chicago Board of Options Exchange Volatility Index. Some investors watch this index to gain a sense of the expected volatility, or unpredictability, of the stock market. The VIX calculates an expected level of volatility for the market by assessing current market prices for instruments such as puts and calls. The number is quoted as a percentage. If the index is accurate, the higher the percentage, the more likely a significant change in the market will occur. Since this index has been around only 12 years, it has not yet been fully tested as an accurate predictor of market volatility.
Keep in mind that the performance of individual stocks or funds that you own can vary, sometimes significantly, from what is reported about the broader stock market.
1 S&P Dow Jones Indices, S&P 500 Fact Sheet, Jan. 29, 2016.
2 MSCI EAFE, Index Overview, Feb. 25, 2016.
William “Drew” Watson CFP® is a Financial Advisor and Private Wealth Advisor with Ameriprise Financial Services, Inc. in Owensboro, KY. He specializes in fee-based financial planning and asset management strategies and has been in practice for more than 20 years. To contact us by phone, please call 270-684-8424, or mail to 111 West 3rd St., Owensboro, KY 42303. You may also visit our website at www.williamawatson.com.