Why Stock Indexes Matter to Your Investments
When investors talk about how the stock market is doing, they’re often referring to one of the benchmark stock indexes. You have probably heard of some of the most well-known ones, such as the Dow Jones Industrial Average, which has been around since 1896, or the S&P 500, which is the broadest measure of the U.S. stock market. You may have even heard that both have risen to record highs this year or that chip maker nvidia bumped Intel from the Dow, ending the tech giant’s 25-year run in the index by better leveraging the artificial intelligence boom.
But what exactly are stock indexes and how do investors use them? We’re getting into it.
Stock Indexes Versus the Economy
Stock indexes track the combined performance of a specific group of stocks. They’re designed to be representative of a certain section of the market and can give investors a sense of how stocks are broadly responding to economic data, changes in regulations and trade policies, or the political climate.
But no, the stock market and the economy aren’t the same, in case you were wondering. They are interconnected, given that the economy is a measure of things that are made, bought, and sold in a given region, and the stock market reflects a critical aspect of the companies that do the making, buying and selling. But they can diverge in noticeable ways. For example, even when the economy is doing well, investor worries about a slowdown in the future can pull stock prices lower.
Two Key Indexes to Remember
One of the most cited indexes is the Dow, which measures the performance of 30 large, publicly traded U.S. companies. It’s measured in points, so you’ll often hear how many points the Dow went up or down in a given day or week. By tracking how these businesses are faring, market watchers may gauge (and infer) how the stock market is doing as a whole. The Dow is a price-weighted average, meaning stocks with a higher share price can influence the index more. The highest-weighted Dow stocks were Wall Street bank Goldman Sachs, insurer UnitedHealth Group, and retailer Home Depot as of December 6, 2024.
The other very prominent stock index is the S&P 500, which tracks a much bigger chunk of the market by following 500 leading, publicly trading U.S. companies. The S&P 500 is weighted by market value rather than share price. Even though all sectors are represented, big tech reigns the index, with Apple, Meta, Google-parent Alphabet, Microsoft, and NVIDIA among the top 10 biggest constituents.
While the Dow is often the most cited index, the S&P 500 can provide a broader, more diverse view of overall market health.
And there are a multitude of other stock indexes tracking different parts of global financial markets. In the U.S., the Nasdaq Composite Index, which focuses on tech stocks, and the Russell 2000 Index, which tracks smaller companies, are also commonly cited.
How Can Stock Indexes Inform Your Investments?
Indexes can help investors understand the overall market sentiment, but they can also offer a point of comparison. For instance, if an investor wants to understand how a specific stock or investment is faring versus the overall market, they might compare it to the S&P 500’s long-term return of roughly 10% (or 6-7% when adjusted for inflation), according to historical data.
You can also base your investments on indexes through investment funds, such as exchange-traded funds (ETFs). These funds allow you to invest in all the stocks in an index rather than purchasing individual securities. If you’re saving for the long-term, such as for your retirement, using average historical market returns can also help you project how much your investments could potentially grow over time.
image credit: Bernie Pesko
photocredit: iStock/Prostock-Studio
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