Personal Finance

Ask a Fool: Why Is the S&P 500 Used as a Benchmark for Performance So Often?

Q: The Dow Jones Industrial Average is the number that usually makes the headlines, but more investors seem to compare their performance to the S&P 500. Why?

The Dow Jones Industrial Average is certainly the attention-grabbing stock index. It's been around since the 1800s, and with the highest numbers of the three top indexes (Dow, S&P 500 , Nasdaq ), it makes for more exciting headlines. This is why it was much more publicized when the Dow crossed 25,000 for the first time than when the S&P 500 surpassed 2,500, for example.

However, the Dow simply isn't a great representation of the overall stock market. For starters, the index only includes 30 companies, so it's just a small cross-section of the thousands of companies in the market.

The Dow is also a price-weighted index, meaning that higher-priced stocks count more, even if they represent smaller companies. For example, Goldman Sachs , with a share price of about $230 has roughly five times the influence on the index as $48-per-share Verizon Communications , even though Verizon is more than double the size of Goldman.

On the other hand, the S&P 500 includes 500 companies that combine to represent about three-quarters of the stock market in terms of market capitalization. And, the S&P 500 is a market cap-weighted index, meaning that the larger companies have more influence over the index.

In short, the S&P 500 is a much better representation of the overall stock market, which is why it's the benchmark that so many investors and fund managers compare their performance against.

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Matthew Frankel has no position in any of the stocks mentioned. The Motley Fool owns shares of VZ. The Motley Fool has a disclosure policy .

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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