Dow Jones VS S&P 500
As you approach retirement, understanding the financial markets becomes increasingly important. At Fortress Financial Group, we aim to demystify these concepts so you feel more confident in your retirement planning. Let's delve into why the Dow Jones Industrial Average (DJIA) is priced so much higher than the S&P 500, even though the latter includes many more companies.
A Quick Recap: What Are These Indices?
To refresh, the DJIA (Dow) tracks the performance of 30 prominent companies in the U.S., while the S&P 500 measures 500 of the largest American companies. Despite the S&P 500 including significantly more companies, the Dow's total price is substantially higher. This discrepancy arises from the way each index is calculated.
How the Dow Is Calculated
The Dow is a price-weighted index. This means it adds up the prices of its 30 stocks and then divides that total by a special number called the "Dow Divisor." Historically, this divisor was simply the number of companies in the index, but it has since been adjusted to account for changes like stock splits and alterations in the list of companies.
As of now, the Dow Divisor is approximately 0.1517. This small number essentially acts as a multiplier, meaning the sum of the stock prices is multiplied by around 6.59. Therefore, a $1 change in any stock within the Dow translates to a movement of 6.59 points in the index. This multiplication effect significantly inflates the Dow's value compared to the S&P 500¹.
The S&P 500: A Different Approach
The S&P 500, on the other hand, is a market capitalization-weighted index. This means each company's influence on the index is proportional to its market capitalization (the stock price multiplied by the total number of shares). Larger companies with more outstanding shares have a greater impact on the index than smaller ones.
Because of this weighting, the S&P 500's divisor is much larger—over 8,000 as of the latest data. This higher divisor keeps the index's value at a more manageable level, ensuring that the price movements of the largest companies don't disproportionately affect the overall index².
History of the Dow and S&P 500
The Dow Jones Industrial Average (DJIA): The Dow was created by Charles Dow, co-founder of Dow Jones & Company, in 1896. It started with 12 companies and has since expanded to include 30 major U.S. companies³.
The S&P 500: The Standard & Poor's 500 (S&P 500) was introduced in 1957 by Standard & Poor's, a financial services company. It was designed to be a broader reflection of the overall U.S. stock market, including 500 of the largest publicly traded companies⁴.
Historical Comparison: Dow vs. S&P 500 Returns
Over the past 50 years, both indices have shown significant growth, but their returns can vary over different periods. For example, over the past 50 years, the S&P 500 has averaged an annual return of approximately 10%, while the Dow has averaged slightly lower, around 9.7%⁵. This slight difference highlights the broader base and diversification of the S&P 500, which can sometimes capture more market growth opportunities.
Understanding Market Movements
When listening to market updates on the radio, you might hear about the Dow or the S&P 500 moving up or down by a certain number of points. Here's what would be considered significant:
For the Dow: A movement of 200-300 points in a single day is notable and reflects a considerable change. Movements of 500 points or more are often newsworthy and suggest a very volatile day in the market.
For the S&P 500: A movement of 20-30 points is considered significant. Movements of 50 points or more indicate a substantial change and are usually associated with major economic news or events.
Why Does This Matter for Retirement Planning?
Understanding these differences is crucial for your retirement planning. Here’s why:
Diversification Insights: The S&P 500's broader and more diversified base can offer a more accurate picture of the overall market, which is beneficial for long-term investment strategies.
Impact Analysis: Knowing that the Dow is heavily influenced by a few large companies helps you understand why its movements might not always reflect broader market trends.
Portfolio Decisions: This knowledge aids in making informed decisions about which index funds or ETFs might best suit your retirement portfolio, depending on your risk tolerance and investment goals.
Consult a Financial Planner
For tailored advice, consider consulting a financial planner or financial advisor. At Fortress Financial Group, located in Rochester, Minnesota, our fee-only fiduciary advisors are dedicated to acting in your best interest. We provide transparent, unbiased advice to help you navigate the complexities of retirement planning.
Conclusion
Understanding why the Dow is priced higher than the S&P 500, despite having fewer companies, equips you with valuable insights into the financial markets. These insights can significantly impact your retirement planning, helping you make more informed investment decisions. If you have more questions or need personalized advice, visit our website at fortressfg.net to schedule a consultation with one of our experienced financial advisors.
Disclosures -
Fortress Financial Group LLC (“FFG") is a registered investment advisor. Advisory services are only offered to clients or prospective clients where FFG and its representatives are properly licensed or exempt from licensure. For additional information, please visit our website at https://fortressfg.net/. For current FFG information, please visit the Investment Adviser Public Disclosure website at www.adviserinfo.sec.gov by searching with FFG’s CRD# 315329. Stock investing involves risk, including the loss of principal. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.
References
¹ How the Dow Is Calculated. Retrieved from https://www.investopedia.com/terms/d/dowdivisor.asp#:~:text=The%20Dow%20divisor%20is%20a%20figure%20used%20to%20normalize%20the,validity%20as%20a%20benchmark%20index.
² The S&P 500: Market Cap Weighting. Retrieved from https://www.spglobal.com/spdji/en/indices/equity/sp-500/#overview
³ History of the Dow. Retrieved from https://www.investopedia.com/ask/answers/100214/when-did-dow-jones-industrial-average-djia-begin.asp
⁴ History of the S&P 500. Retrieved from https://www.investopedia.com/ask/answers/041015/what-history-sp-500.asp
⁵ Historical Performance of Dow vs. S&P 500. Retrieved from https://www.spglobal.com/spdji/en/research-insights/index-literacy/the-sp-500-and-the-dow/
