EPS 17 - Dow, S&P 500, and NASDAQ Demystified: What Market Indexes Really Mean

 In this episode of the Pink Money Podcast, Jerry breaks down the meaning behind the daily headlines about the Dow, S&P 500, and NASDAQ. He explains how each index works, why they’re tracked, and what they really mean for your portfolio. From the history of these indexes to how portfolio managers use them as benchmarks, this episode gives you a clear, practical way to understand what the market updates on the news actually tell you. 

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Transcript

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bills hey hello hello hello this is jerry and welcome back to the pink money podcast where we talk about all things related to money from a gay perspective and you know um Every time I listen to the news, of course, you know what always jumps out at me or how often you always hear, you know, the Dow did this, S&P 500 did that, and the Nasdaq did this, and da-da-da-da-da. And they throw that out all the time. Anytime you listen to really any newscast, they're going to really, when they're talking about the market or they're talking about the economy in general, they're always going to throw those three out. Now, are those the only indexes in the world? No. There are literally thousands and thousands of indexes, and they keep getting made all the time. But in a broad sense, these are the ones that represent the greatest cross-section of companies that represent the largest U.S. companies. And that's... Usually the reason why they track them and quote them is because they're so familiar to everybody. Now, the Dow, that was probably the earliest one index that was ever created. I believe that was created in 1896 by Charles Dow and Edward Jones. Not to be confused with the Edward Jones with the investment offices all over the US, but a different one. Nevertheless, that was created way, way back. And it was only created with like a handful of companies way back then. And the idea was to use these companies as a way to gauge the overall market health and it worked right because there was nothing else before that but you know that lasted for quite a while in fact i think the s&p 500 began in something like 1957 and the nasdaq i think was created in 1971 and so those index was indexes were created because they wanted something that was a little bit more broad and a little bit more specific. Now the Dow, that is a price weighted index, meaning that the price of these companies' stock is generally what's taken into consideration. Now, that has also changed over time because the divisor is always changing because they take into account things like stock splits, stock substitutions, any significant dividend changes. So it's not really just a pure arithmetical average, but it is a way to indicate stock market trends and price trends because originally they just simply took the stock prices and divided it by 12. And like I said, that's just not really going to work anymore because there's so many different factors that come into play. But compared to the S&P 500, that is a market weighted index, meaning the size of the companies is what matters more than anything else. And because these are great big, large, gigantic companies, these are the big daddies out there. They're called like blue chip stocks because they're the ones that are, again, the most familiar to most everybody, you know, for the most part. You may not have heard of all of them, but you've heard of many of them. Now, I know that there's like six companies that are listed on both the S&P 500 and the Dow, like Apple, Johnson& Johnson, Microsoft, Procter& Gamble, Salesforce, and Visa. So that's not usually the case, though, because now each one of these indexes are going to pick different companies for different reasons. Now, The S&P 500, that's a totally different beast in and of itself. Because the NASDAQ, what they're really looking for are companies that are focused on technology and innovation. And generally, these have a tendency to be some of the larger ones, but they also can be a lot of fast-moving companies. So when you're talking about, you know, great big, large, gigantic companies that are valued at like over$10 billion, they are the big ones, you know, that you've generally heard of. Some of the top ones in the Dow would be Of course, Apple, Boeing, Caterpillar, Chevron, Cisco, Coke, Dow, Goldman Sachs, Home Depot, IBM, Intel, McDonald's, et cetera, Nike. So you've probably heard of almost every single one of those. And the S&P 500, you've heard of some of these companies as well. Tesla, JPMorgan Chase, Microsoft, Alphabet, or Google as their daddy, parent company is called Alphabet, Amazon. So those companies you've generally heard of And again, because these are the great big, large, gigantic companies. And that's a simple way for everybody to gauge what is the general direction in health of the U.S. economy. So, you know, they'll say the Dow was up, the S&P was down, the NASDAQ was, you know, up or down, what have you. So it doesn't really mean everything to you it just gives you a general sense and that's the reason that they quote it it's just a way for you to say hey you know what's really happening in the market and how's things how are things going out there if everything's down then you know there's some problems somewhere and who knows what's going on war is always a good one to create a lot of havoc out there and you know especially what's going on over and um uh you know with russia and uh Ukraine, so that creates a lot of uncertainty out there. But anything can happen. U.S. elections, that creates a lot of uncertainty, too. So... What does that mean to you in regard to your portfolio? What that really means is when you're building your portfolio, you're going to have to use something to gauge the performance of your portfolio. Now, in a general sense, you can always just say, hey, is my portfolio worth more than what I put into it? Yeah, right? You always know if you lost or gain money. But if you've been dollar cost averaging in your portfolio, let's say, meaning you're putting money consistently in it over a period of time, let's say you add, you know, money every month, then that can be a little bit trickier because you don't always buy at the same price, right? You buy high, you buy low, you buy in between. And so for you to just simply look at one gauge and say, oh, my portfolio is doing really well. It may not mean everything to you. And the portfolio manager themselves, they may not use the same way of tracking your performance as they do their performance. So if in a mutual fund, many times they use just the S&P 500 or they use a combination of indexes. Now, there are literally, like I said, thousands of indexes out there from not only just the U.S., but all across the world. But generally, the portfolio managers will at least use the S&P 500 because because they're going to invest in these great big, large, gigantic companies because they have a lot of money to invest. And it takes a lot to propel a portfolio that has billions and billions of dollars in it. And they can only take such, you know, They can only take positions in companies to a certain degree. I mean, if they invested all their money in, let's say, a really small company, then, of course, they would own all of it. And that wouldn't be a good idea because, you know, again, nobody should put all their eggs in one basket. And they're certainly not going to do that. But they will probably quote the S&P 500 as a way for you to use and for them to gauge their performance as a benchmark. Now, I don't think I've really heard of anyone using the Dow as a benchmark. benchmark. Nobody that I can really think of, and any prospectus I've ever seen, I don't think they've ever used the Dow Jones. Now, again, they quote it every night on the news, but that doesn't mean it's really widely used in regard to performance, because again, it is just 30 of the largest U.S. companies that don't always represent the greatest cross section out there, but it is what it is. It's an old index and it is a price weighted index, which is more difficult to replicate as well versus S&P, which is a market weighted index, which is a lot easier to replicate. But nevertheless, you will probably always see the S&P 500 as one of the main indexes, but they may also need to employ other indexes because they don't invest probably in just those 500 companies. They probably invest in small companies. They invest in medium-sized companies. They may invest globally, meaning in the U.S., but also outside of the U.S. So they may also invest in commodities, gold, et cetera, real estate. So they're going to probably use a few different indexes as a way for them to use a... an ability for you to assess the portfolio's performance. Now, when you call your investment company and you start speaking to them about, you know, how's the portfolio doing, they will probably go straight to those indexes and give you that. And they're going to tell you, well, overall, the portfolio is up this year, down this year, you know, it's going sideways, what have you. And then they're going to probably quote the one year, five years, you know, 10 year, if it's been around that long, as a way again, for you to get a general sense. Is that going to be exactly what your portfolio is doing no of course not but it's just a way you know for you to get a general sense of what's going on and for you to make sort of an informed decision when you get your statement of course then your investment company will typically have your individual performance and that is a lot more instructive to you because you really know you really want to know what's happening to you not to everybody else you want to know what's happening to you now going forward you might want to wonder you know what's a portfolio manager got in mind probably it's not going to be a whole lot different than what you've already been investing in because that's the whole reason you're invested in this portfolio to begin with. Let's say if you're invested in the S&P 500, it's not going to be anything different than what it is. So year in and year out, it's going to be the same 500 companies in that same S&P 500 until the portfolio, and I'm talking about the S&P 500, the guys that manage that, then they're going to add companies and pull them off as they see fit. And that doesn't happen every single day. I believe the last time they rebalanced the S&P 500 was maybe back in 2020. I think there was like three companies that I'm aware of that were taken off and three companies that were added. I believe they removed Exxon, Pfizer, and Raytheon and added Salesforce, Amgen, and Honeywell. And the reason why some of these companies are dropped, it's not that they're terrible companies and that they're really struggling or there's a big red flag. It just means that maybe some things have certainly changed for the company and maybe they don't represent a good smattering of what they were looking for any longer. So for example, I know Pfizer was removed because they were experiencing a lot of competition from generic drugs and they were struggling to bring new drugs to the market. And so as a result, their stock was underperforming. Raytheon I know merged with another company and they became, you know, Raytheon Technologies, I believe. And because they are a defensive type company, a lot of countries were pulling back in their investments in defense. So again, their stock started to underperform and that was one of the reasons they decided to pull it. But You know, there can be all kinds of different reasons why. And maybe something like a Salesforce, which hasn't been around forever, right? Versus something like, you know, one of these other companies that have been around forever and ever. It can be just that Salesforce maybe is a better representation of What is going on today? How many more companies are using software like Salesforce to manage their customer service databases, et cetera? And it just is a company that's been on the rise, has been around long enough that it qualifies in terms of its market capitalization to be added because it's significant enough. Now, is that a significant enough company to add to the S&P, excuse me, the NASDAQ? Maybe. I don't know. But that doesn't mean it has to be. Right now, I think some of the NASDAQ companies we're talking about, again, like Facebook and Microsoft, Netflix, PayPal, Zoom. So, again, NASDAQ is just focused more on technology. So if, let's say you wanted to invest in these companies because you like them, they're in good name recognition, or they have good name recognition, and maybe you feel like, hey, I wouldn't mind putting some money into those because, you know, I can't afford to buy each of those individually, but, you know, I might be able to go into, say, like a mutual fund or exchange-traded fund, an ETF. Yeah, yeah, you can do that. Now, I don't, again, know of any particular mutual fund. Maybe there's an ETF exists out there that, you know, allows you to invest in the Dow. But I'm really not familiar with one. Don't quote me on that. There might be one. I'm just not aware of it. But there definitely is mutual funds and ETFs that are S&P 500. And they mirror that either exactly or very closely. And you can easily get into that. And when you're looking at that, you just want to make sure that the expense ratio is pretty low. Because in that kind of an index, there's not a whole lot of... portfolio management that really needs to take place because of course they have to manage the inflows and outflows and there's you know that kind of stuff that goes on but they're not the portfolio manager isn't necessarily out there kicking the tires and looking at this from the ground up because they don't really make the decisions where whether to add or subtract companies from the S&P 500 500 you know S&P 500 index they do that themselves so you know, an active portfolio where, you know, the portfolio managers do make all those investment decisions, what companies to invest in, then the expense ratio is going to be higher, of course, because there is a lot more research that goes into it, they need to actively get out there, speak to the management team, do their bottoms up approach. And meaning look at everything from their competitors to what's going on inside the company, talking to everybody and their brother to see, you know, whether this company is still viable, and if they got a good strategy, and are they a that we're willing to put millions of dollars in because they're not just putting their own money into it. They're putting yours and mine and everybody else who's got their money into it. So they want to make sure that whatever they're investing in, it's essentially going to be a good bet. So can you invest in these indexes? Maybe sometimes, but not all the time. And if let's say you wanted to invest in every single company that invested, you know, that every single company that was a publicly traded company in the world, could you do that? Yes, you can do that through something like the Wilshire 5000. And that is an index that tracks essentially every company that's publicly traded around the world. And that is included in the Wilshire 5000. And you can invest in that. And that might be So even though it is comprised in and of itself of thousands of companies, you have just one mutual fund. So do you want to invest in just one or do you want to be more diversified? And, you know, we've always heard that old saying, I've said it a thousand times, don't put all your eggs in one basket, right? It's never a good idea. So it is diversified, but you might want to consider adding and supplementing your portfolio with something else. Now, I've talked strictly about stocks at this point. Now, we know that there's also bonds and there's real estate and there's also commodities, et cetera. Now, it really just depends on what these bonds bonds or whom these bonds are issued by meaning there's government bonds corporate bonds and there's different grades of bonds you know there's junk bonds all sorts of stuff so bonds are not represented in anything that i talked about the dow the s&p 500 or the nasdaq wilshire 5000 or anything those are just strictly stocks that are issued by these companies bonds totally different beast totally different indexes and you'd have to go something like the Barclays aggregate index. And you know, there's various bond indexes that exist out there as well. Yes. Portfolio managers, because they do typically invest in both stocks and bonds will generally use another index is again, that matches what their investment strategy is. Does that mean they're going to invest in every single thing that's out there? No, they're going to be pickier than that. And of course that's what you're going to be paying them to do is to make those investment decisions for you and I and everybody else. So again, The strategy, again, of creating a portfolio, what to invest in, also goes with what the overall objective is. And then that objective also ties into how are we going to measure it. And that is up to the company to pick an index that is going to closely match whatever the investment strategy is. And that gives you the best way to gauge the performance of the portfolio. So those are just, pardon me, just a high-level idea of what you want to look at and what you want to think about when you're hearing this every night on the Dow, the S&P 500, and the NASDAQ. It's just a general way for you to gauge what the market is doing and how the economy is doing on that specific day because it is just a snapshot in time right then and there that day. It does not represent everything that's been going on for the last year, et cetera, et cetera. Totally different. So I can go on, you know, to more detail. You can research this, you know, to your heart's content. Definitely when you're looking to invest, you know, if you don't know what you're doing, definitely get some, you know, professional money management advice. Seek, you know, competent tax legal financial advice if you're not able to do it on your own. So I won't belabor the topic anymore. I just thought it was something that popped in my head and I thought it would, you know, speak to you about it for a few minutes. I think that's pretty much it for me today. I'm going to go ahead and jump out and we will talk again later. You have a great day.