Most other stock indices are much better constructed and useful as a benchmark index, including the S&P 500. While S&P 500 does only capture about 75% of the stock market it is pretty much indistinguishable from a total stock market, so far.

And again there is a divisor involved so that changes that don’t reflect changes in underlying company values don’t result in changes to the index’s value.

The number of futures traded in the Dow (YM): 158,225

Wow, that’s a lot! Except that

The number of futures traded in the S&P 500 (ES): 3,079,148.

The volume in S&P 500 futures is ~ 20 times that of the Dow futures. Yet every time you turn on CNBC or what have you, the Dow is getting way more attention than the S&P 500. Why is this? I don’t know, but it’s pretty damn silly.

Listen, the divisor for the Dow is arbitrary. Adding or removing companies for the Dow is arbitrary. Furthermore, it’s a price weighted index, which makes very little sense. IBM and Microsoft are both in the Dow. IBM has a stock price of $160 and a market cap of $200 billion. Microsoft has a stock price of $27 and a market cap of $225 billion. Microsoft is a bigger company than IBM, but because IBM has a larger stock price, IBM has more weighting in the Dow. If IBM is up 10%, the Dow will be up more than if Microsoft is up 10%, even though Microsoft is the bigger company. THIS DOESN’T MAKE SENSE. The S&P 500 does not partake in this nonsense and is market cap weighted.

Whenever someone is talking to me about the economy or whatever and they start referencing the Dow, I turn my brain off. In the financial world, it is a very unimportant index and I don’t really understand why the media treats it as a barometer for the economy instead of its more important big brother, the S&P 500.

I also am interested further in the ‘magic’ to get the divisor, but thank you for this article!

Performance measured against the S&P 500 only makes sense if all of your investments are in US Large Cap stocks. Highly recommend the linked article that goes into additional detail, but, as usual, Get Rich Slowly offers a solid thoughtful guest post on the meaning of the most widely reported index.

Is the SP500 weighted too? I thought it just add up all the stock price.

I’d also be interested to know more of the “yada yada yada” between adding up the prices and then dividing by the “divisor” but I assume the explanation is pretty tedious?

In other words, I echo the confusion above.
Where’d the divisor come from, for example?

When a stock splits, the company says if you have x shares of our stock, you now have y. and the value of each share is adjusted to x/y. So a 2:1 (y:x) split cuts the price of the share in half. (more here: http://en.wikipedia.org/wiki/Stock_split )

To simplify it, lets say every single stock in the index splits 2:1, so the price of the shares is cut in half. If there was no divisor the index would be cut in half as well, but that would be misleading, since the value of the companies in the index didn’t get cut in half. The divisor is used to compensate for this, so the divisor is adjusted (in this case, cut in half) so the index remains constant before and after the split. The same thing applies to when they swap out companies in the index, the divisor is adjusted to keep the index at the same level as it was before the swap.

Least-explanatory explanation ever. Might as well say, “we add up the stock price of all the included companies, apply magic, and there’s 12,000, which is your DJIA.”