Jill On Money: Stock market milestones
With U.S. stock market indexes reaching new highs and round-number milestones, it is time for a refresher on the differences among them.
Although these measurements have become a quick way to gauge what’s going on in markets, they are by no means the whole story. And of course, your investments may or may not track the path of stock indexes, depending on your specific allocation.
The “Dow” was introduced in May 1896 and along with the Dow Jones Transportation Average and Dow Jones Utility Average, these indexes provided the public with a snapshot of financial market performance.
When it began, the Dow tracked 12 companies, which were representative of the most important industries in the U.S. By 1928, the index included 30 companies, which is still the number that are included in the index.
Although the Dow is the oldest index, it is problematic because of the way it is calculated. The Dow is price-weighted, which means that higher-priced stocks have a larger influence on the index.
For example, Microsoft, which is trading at over $400 per share is a much more important contributor to the Dow than Verizon, which is trading at $40. Despite its history, the small size of the index, along with its price-weighting methodology makes the Dow the least efficient way to determine what’s going on in financial markets.
The “S&P 500” was introduced in March 1957 and was intended to address some of the shortcomings of the Dow. Instead of 30 stocks, the S&P tracks 500 U.S.-based companies, which cover about 80 percent of the overall market.
Additionally, the S&P 500 is weighted based on market capitalization (“market-cap”), which is calculated by multiplying the number of shares outstanding by the current market price. Those companies in the S&P 500 with the highest market cap have the greatest impact on the value of the index.
The National Association of Securities Dealers Automated Quotations (“NASDAQ”) was launched in 1971 as the world’s first electronic stock market.
Eventually, this innovation led to the elimination of physical trading floors, which relied on human beings to transact buy and sell orders. (The New York Stock Exchange trading floor is now just a backdrop for financial media.)
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