October 27, 2022
S&P 500. Dow Jones. Nasdaq. Russell 2000.
Odds are, you’ve heard of one or more of these before. Either in passing, in the media, or in casual conversation with friends or colleagues. They are America’s biggest indexes, which is a hypothetical portfolio filled with assets, crafted by selection committees.
Millions of Americans own a slice of these indexes through passively-managed mutual funds and exchange-traded funds (ETF). For example, ETFs like $QQQ track the Nasdaq 100, $SPY tracks the S&P 500. If you have a 401(K) or IRA, you probably count yourselves among the millions of people with money tracking these portfolios of stocks.
However, despite all the people with money in the line in these indexes, many people are unfamiliar with just how influential they are when it comes to the market. But, what are these indexes, how did we get them, and what do they hold? Today, we’ll take a look at America’s leading indexes.
The S&P 500, otherwise known as the Standard and Poor’s 500, is an index which tracks the 500 largest companies in the United States. Companies are weighted in the index by market capitalization, a measurement which looks at the total value of a company. The index was founded in March 1957, making it one of the oldest indexes in America.
Often, when people talk about how well the stock market is doing, they will be talking about the S&P 500. Its prominence can be credited to its reach in ETFs: over a trillion dollars track the S&P 500 in ETFs such as $SPY, $IVV, and $VOO.
The S&P 500 has a selection committee which requires companies to be based in the U.S, have at least 50% of the company be available in the “public float” (as opposed to the government or the company’s insiders). The market capitalization needs to be at least $8.2 billion. The company also needs to have positive earnings over four consecutive quarters.
The five biggest holdings in the S&P 500 are America’s largest companies: Apple, Microsoft, Amazon, Facebook, and Alphabet. These five holdings comprise 21.9% of the index as of June 2021.
Dow Jones Industrial Average
The Dow Jones Industrial Average is the oldest of America’s indexes. When it was founded in May 1896, it held just 12 companies. Today, it remains America’s “smallest index,” but it eats up a considerable amount of media attention and buzz in spite of it.
The 30 companies in the Dow Jones Industrial Average (DJIA) are actively selected by the editors of The Wall Street Journal. As such, it makes the DJIA a bit of a curveball compared to other indexes that have elaborate selection committees and criteria. Another curveball is that the DJIA uses price-weighting, which is different from the market capitalization weighting of other major indexes.
To some, these idiosyncrasies are what make the Dow Jones Industrial Average a golden standard on markets. However, it’s also a reason why less money tracks the DJIA than other leading security market indicators. There’s only one ETF which tracks the Dow Jones Industrial Average, which manages just $30.4 billion in assets. That doesn’t necessarily mean it’s bad, though. The DJIA has averaged strong returns over the last decade, sometimes exceeding the success of other indexes.
Today, the five largest components of the Dow Jones Industrial Average include UnitedHealth Group, Goldman Sachs Group, Home Depot, Microsoft, and Boeing. The five holdings comprise 30.6% of the index as of June 2021. The last shakeup of the index, which took place in August after Apple’s stock split, added Salesforce, Amgen, and Honeywell International.
The Nasdaq-100 is an index which tracks the 100 largest non-financial companies listed on the Nasdaq stock exchange. It is composed largely of software and tech companies, which are weighted by market capitalization. The Nasdaq-100 was launched in January 1985.
As far as indexes go, the Nasdaq-100 is the most recent index to come to prominence. Its rise is credited to rising reliance on tech companies in the U.S. economies. Its $187 billion of assets are a far cry from some other indexes, but that doesn’t mean that it is necessarily an inferior index.
In fact, it happens to be the index in vogue: Nasdaq-100 has risen over 766% since its inception in 1985 and 552% of that has come in just the last ten years. That equals up to a 55.2% annualized return on average over the last decade. And, that’s not all: the Nasdaq-100 has only reported six down years out of its 35-year history. Pretty crazy, right?
The five biggest holdings in the Nasdaq-100 are, unsurprisingly, shared with other major indexes: Apple, Microsoft, Amazon, Alphabet, and Facebook. These five holdings comprise 35.6% of the index as of June 2021. Many other high-profile members have helped float the Nasdaq-100 to its monolithic gains, such as NVIDIA, PayPal, and Netflix.
Russell FTSE has three indexes: the Russell 1000, 2000, and 3000. The 3000 is an index dedicated to tracking the market and the 1000 and 2000 take after it. The large-cap Russell 1000 is dedicated to the top 1,000 stocks in the Russell 3000. I’m sure by now you’ve already connected the dots and assumed that the small-cap Russell 2000 is dedicated to the bottom 2,000 stocks in the Russell 3000.
However, quite paradoxically, it is the Russell 2000 that has become the latest keystone index in the U.S. Why? Because those 2,000 companies are small-cap growth companies. The fund was started in 1984 and has appreciated increased interest over the last two decades. However, interest in the index is a far-cry from other large indexes. The Russell 2000 has just $77.6 billion in assets tracking it as of June 2021.
Every year, the Russell FTSE indexes undergo a reconstitution process which helps “re-score” holdings in the indexes based on their market capitalization. This is meant to refresh the holdings in the list and make sure that they’re still in vogue. However, because of the Russell indexes’ large number of holdings, this can also lead to some pretty interesting outcomes.
The five biggest holdings in the Russell 2000 are AMC Entertainment, Caesars Entertainment, Plug Power, GameStop, and Novavax. Unlike other indexes, however, these holdings take up a miniscule amount of weighting. After all, there are over 2,000 companies in this index. These holdings comprise just 2.7% of the index as of June 2021.
So, the question: what index should I invest in?
One thing you should know about America’s four largest indexes is that one is not theoretically superior to another. Past performance does not necessarily predict future performance. If that were the case, then the S&P 500 would be consistently leading other indexes.
The indexes cater to specific niches. In some cases, they overlap in terms of offering exposure to assets. For example, the S&P 500, Nasdaq 100, and Dow Jones all share some overlap in terms of assets. That’s because they’re designed to do that, but at different scales.
What we mean is that what index you decide to track desires context. For example, if you’re trying to measure your own portfolio up against one (or more) of these indexes? You probably want to make sure it’s a fair comparison. If you have a portfolio composed mostly of small-cap growth stocks, your best benchmark would likely be the Russell 2000. If you have a portfolio made up of tech stocks, maybe the Nasdaq-100 would be a better comparison. If you focus on companies with larger market capitalizations, then maybe you’d compare to the S&P 500 or Dow Jones Industrial Average.
But that said, they all serve their purposes.