They are very similar, yet very different. A closer look.
The S&P 500 and the Dow Jones Industrial Average are interchangeable to many investors. But they are different, and those differences matter, especially at key market inflection points. We could be nearing one, so it pays to take a closer look
.The chart below shows the past 20 years of returns of the S&P 500 and the Dow. Importantly, I have charted for you the 3-year annualized return, including dividends. That is, if you look at the far right side of the chart, the Dow has gained 16.65% per year for the past 3 years, while the S&P 500 has returned 14.03%.
There is a lot to break down here. First, the Dow and S&P 500 tend to closely match each others’ returns over long periods of time. So any time I notice a significant advantage for one over the other, I want to point it out to you. As the bottom section of the chart shows, the S&P 500 has under-performed the Dow by 2.6% a year over the past 3 years. Historically speaking, that is pretty high. In fact, it is the highest Dow outperformance of the S&P 500 since the late 1990s.
When does the S&P 500 beat the Dow?
Generally, the S&P 500 tends to perform better than the Dow in earlier stages of bull markets, and when tech stocks perform much better than the overall market. That is because a small number of now-giant companies (FANG stocks, etc.) have helped make the S&P 500 a tech-heavy index. Conversely, tamer sectors such as Utilities and Basic Materials are much smaller portions of the S&P.The Dow tends to fare better when the market has gotten expensive, as it is currently. That’s because the S&P is more exposed to “yesterday’s winners,” the stocks that have gone up the most in price the past few years. That is the case with most indexes based on market capitalization.
The Weighting is the Weirdest Part
The other big difference is that companies in the S&P 500 are weighted according to how much stock is out there to be had (“market capitalization”). So, the bigger a company gets, the bigger its impact on the S&P 500. The Dow is weighted very differently, a quirky price-weighed method I have described to you before. The higher the current stock price, the higher the weighting the stock has in the Dow index.Neither index has what I would call a very applicable weighting system for investors. When you set out to invest in stocks, I don’t think most of us think about weighting our stock positions the way either index does. However, this is a big part of the problem with S&P 500 Index investing. It forces you to invest the way the index is allocated, not the way you or a professional investor would likely arrange your stock positions
Beyond S&P 500 and Dow performance is a bigger question: what type of reward and risk can you take on, now and in the future? That is a personal decision, but hopefully an informed one. They are different, even though they perform similarly much of the time.This would be a terrible time to just blow off that idea and be complacent. The S&P 500 and Dow Industrial Average have a lot to offer, but thinking beyond their pre-packaged forms could just make the difference between retiring, and retiring well.Related: What Really Is “The Stock Market?”