Dow vs NASDAQ vs S&P 500: What’s the difference?

2024.12.19 2024.12.19
Dow Jones vs S&P 500 vs NASDAQ: What’s the difference?

Artem Shashkovhttps://www.litefinance.org/blog/authors/artem-shashkov/

Dow Jones, NASDAQ Composite, and S&P 500 are the three most followed stock indexes in the US. The main difference between them lies in the composition of securities.

The NASDAQ Composite consists of more than 50% of stocks owned by well established companies in the high-tech sector. The S&P 500 contains 505 stocks of US companies with the largest capitalization. And Dow Jones includes stocks of the 30 largest US corporations.

This article will describe the influence of these and other differences on the investment attractiveness of each index. 

Major Takeaways

• The Dow Jones stock index comprises stocks of 30 major US companies representing various sectors of the economy.
• The S&P 500 consists of the 500 major US companies, making it more diversified.
• The Nasdaq index covers mainly the technology sector, including fast-growing companies in the IT industry.
• The main difference between the Dow Jones, S&P 500, and Nasdaq lies in how these indices are comprised and respond to fluctuations in various market sectors.
• Index trading allows investors to profit on market rises or falls without having to buy stocks of individual companies.
• The indices differ in their calculation methods. The Dow Jones index is derived from the stock prices, while the S&P 500 and Nasdaq indices are based on market capitalization.
• The S&P 500 index is considered a barometer of the US economy, while the Nasdaq index is often associated with innovations.
• The volatility of the Nasdaq index is higher compared to the Dow Jones and S&P 500 indices, making it a riskier instrument to trade.

What are the Dow, Nasdaq and S&P 500?

Any index is a coefficient calculated on the basis of its constituent stocks. Each stock index is a kind of “barometer” for a particular segment or economy as a whole. For example, the NASDAQ Composite reflects the state of the high-tech sector, the Dow Jones reflects the big business performance, and the S&P 500 reflects the overall health of the US economy.

Also, these indices have differences in the calculation formulas. The S&P 500 and the NASDAQ composite are capitalization weighted indexes, they take into account market cap: the more securities a company has, the more it influences the index. The Dow Jones is a price weighted index, its calculation is based on share price only, not capitalization.

The Dow Jones Explained

The Dow Jones index is called “industrial”, but this is nothing more than a tribute to history. At the beginning of its formation, the main economic power was in the industrial sector, which comprised the bulk of the index. Currently, the overall state of the US economy has the greatest impact on its quotes.

Important foreign economic factors that influence the value of the index are relations with other countries, for example, the presence/absence of new international projects. High labor productivity and low inflation support the growth of Dow Jones. Interestingly, the index often strengthens amid a weakening US dollar. The Dow Jones Industrial Average is listed on the New York Stock Exchange and NASDAQ stock exchange.

The main disadvantage of the Dow Jones Industrial Average is that only stock prices are taken into account in the calculation. Thus, if a company has a smaller capitalization, but a more expensive share, it has a stronger influence on the index than a larger company with cheaper shares.

The Nasdaq Composite Explained

The NASDAQ Composite index consists of companies’ shares that are traded on the NASDAQ stock exchange. It includes more than 2,000 US and international companies. More than half of them are from the technology sector.

The index includes common stocks or derivatives such as American depositary receipts and real estate funds. Preferred stock, warrants, ETFs, and closed-end funds cannot be included.

The top 10 most influential companies in the NASDAQ Composite index are:

• Apple;

• Microsoft;

• Amazon;

• Facebook;

• Alphabet Class C;

• Tesla;

• Alphabet Class A;

• NVIDIA;

• PayPal;

• Intel.

After 2000, the NASDAQ vs. Dow vs. S&P 500 shows the fastest gains. Since the dot-com bubble in 2003-2004, the NASDAQ’s annual returns have outperformed the S&P 500 and the Dow Jones Industrial Average in more than 50% of cases.

S&P 500 Explained

The S&P 500 was created in 1957 by Standard & Poor’s (developed from Standard Statistics Company). It consists of 505 shares of 500 companies that meet the requirements on:

Failure to comply with one of them entails exclusion from the index. Every quarter there is a rebalancing, and weakened companies are replaced with new, stronger ones.

It is a mistake to say that the largest US companies are included in the index. Some of them are privately owned and/or not liquid enough.

Like the NASDAQ Composite, the S&P 500 is capitalization weighted index. Shares of companies included in the S&P 500 are traded on the NYSE and NASDAQ stock exchanges. The index itself is traded on weekdays during the American session.

What Is the Difference Between Nasdaq, S&P 500 and Dow Jones?

Each index has its own set of instruments on the basis of which it is calculated. Usually, these are securities of a certain sector of the economy or globally significant players. In the first case, the index price changes reflect the local situation in the industry. In the second one, the overall US economic performance is shown. The more securities in the index, the more accurate it is.

Roughly speaking, Dow vs NASDAQ vs S&P is big business vs high tech vs the general economy.

Size

Nasdaq has over 2,000 stocks, the S&P 500 has 505, and the Dow Jones Industrial Average has 30. Despite their differences in size, the main drawback they share is heavy reliance on large companies.

Calculating the NASDAQ index vs Dow Jones is based on the capitalization of the companies, so stocks of large corporations have a strong influence. A total of 100 largest businesses make up 90% of the index’s value. The situation is the same with the S&P 500, the companies from the top 10 of the NASDAQ index have the greatest influence on it.

The Dow Jones, with its 30 companies, is the least diversified of the three stock indices in theory. In practice, NASDAQ Composite and S&P 500 feature just a bit better diversification. It is because most of the companies included in indexes have minimal impact on their prices.

In the context of day trading, the Dow Jones is the most volatile, stop losses will be longer compared to the S&P 500 and NASDAQ. When the economy is growing, the NASDAQ will have the most potential rise and, therefore, the largest take profits in swing trading.

Sector diversification

NASDAQ Composite includes 52% high-tech stocks and 16% consumer stocks. It is a broad based index and the industry diversification is minimal. In the case of the S&P 500, the division by sector is more diverse: IT – 27%, healthcare – 15%, durable goods, and communications – 11% each. Thus, the distribution of the S&P 500 vs NASDAQ is more even: 64% for 4 sectors versus 66% for 2 sectors.

Therefore, the S&P 500 will be more stable than the NASDAQ composite during the turmoil in any one of the significant sectors. But it will not show rapid growth in case of an economic boom.

The Dow Jones Industrial Average is the most diversified by industry. The maximum share of the industrial sector is 21%, followed by financial services – at 18%, consumer services – at 17%, and healthcare – at 15%.

The total distribution of the Dow against the S&P 500 is 71% for 5 sectors versus 64% for 4 sectors. Therefore, the response to a boom or crash in one of the industries, in the case of Dow Jones, will be the smallest.

Selection criteria

Each company included in the S&P 500 meets the following criteria:

• Market capitalization is ≥ $6 billion:

• The monthly trade volume on the exchange is ≥ 250 000 stocks;

• Last year’s profit;

• Percentage of shares in public circulation > 50%.

The S&P vs Dow is more dependent on clear quantitative criteria. In particular, the Dow does not have a requirement for a minimum volume of shares traded. 

The minimum requirements include:

• Reliable business reputation;

• The activity of investors in relation to the company;

• The head office is in the USA.

Companies for Dow Jones are selected from among those included in the S&P 500. As a result, their total market capitalization in the Dow vs S&P cannot be less than $6 billion. The final decision on the inclusion of shares in the index is made by a special committee of 5 people.

To be included in the NASDAQ Composite index, a security must be traded on the NASDAQ exchange. Exceptions include preferred shares, exchange-traded index funds (ETFs), and derivatives.

Dow Jones Industrial Average, NASDAQ and S&P 500: Price trends compared

The performance of all three stock market indices is highly dependent on several large companies that participate in the Dow Jones, NASDAQ, and S&P 500. For example, Apple, Intel, Microsoft, and so on. As a consequence, these three indexes often rise and fall at the same time. The charts reflect the trends of the stock market performance for the period from 2018 to the second half of 2022.

Dow Jones:

NASDAQ Composite:

S&P 500:

In my opinion, the stock market’s performance and the price trends of the indices are quite similar. In particular, a sharp price fall starts in early 2020 because of the pandemic. Next, prices rise steadily till early 2022. In the second half of 2022, all three indexes are trading the downtrend amid political tensions in the world. 

Let us see how much each index lost in 2020:

• Dow Jones dropped from 29595 to 19000, which is 36%;

• NASDAQ Composite dropped from 9800 to 6900, which is 30%;

• S&P 500 dropped from 3400 to 2300, which is 33%.

The reason is that all industries have been affected by COVID-19. The Dow Jones fell the most, as it was more dependent on the few companies with the most expensive stocks. In the S&P 500 vs Dow Jones, the influence of large companies is balanced by a few hundred smaller ones. Therefore, the fall is more smoothed. The NASDAQ composite, as the most diversified in terms of the number of companies, turned out to be the most resilient of all.

Next, let us have a look at the price growth until the high of 2022:

• Dow Jones rose from 19000 to 36200, 90%;

• NASDAQ rose from 6900 to 16100, 133%;

• S&P 500 rose from 2300 to 4800, 108%.

The Dow Jones Industrial Average rose the least of all, as expected, as exponential growth for blue chip index is usually in the past. In second place is the S&P 500, which is less dependent on large corporations and diversified by young, ambitious companies. And the undisputed leader is the NASDAQ Composite due to the large share of online businesses that are less dependent on the pandemic. This led to a difference in the yield of the NASDAQ vs Dow by almost 50%.

NASDAQ vs Dow vs S&P 500: Which Is the Best Investment?

Which index is the best for traders and investors? This question sounds like “What is the best sport for a sportsman?”

Dow Jones will suit investors with a conservative strategy. A benefit of the DJIA is its orientation to profitable companies, resilient to crisis. 

Investments in the NASDAQ are associated with high risks and greater potential profit targets as it is focused on companies within the same industry of more than 50%. It is both an advantage and a flaw at the same time. At present, high technologies in terms of development speed resemble the crypto market, so the geometric growth of the NASDAQ Composite is still possible. It will be suitable for moderately aggressive trading or investment strategies in the stock market.

The S&P 500 is the most diversified and average option. During the global growth of the total stock market, investors and traders are attracted by companies with low-cost shares and relatively low capitalization included in the index. However, those same investors may accelerate the decline of the index by selling such assets to buy the blue chips of the Dow Jones.

Invest in the S&P 500 and reach large cap stocks

Here, derivatives of the index are meant, of course. The S&P 500 itself is nothing more than an indicator.

 The average annual total return is 9.7%, including dividends. This is a planned indicator when choosing an investment instrument.

 I see three options to invest in the S&P 500 stock index

• ETFs. These are marketable securities. ETFs represent a share in the portfolio of securities, which is compiled by the fund. The portfolio will consist of shares of companies included in the index in the same proportions. The most famous S&P 500 ETFs are Invesco (stock ticker #QQQ) and SPDR (stock ticker #SPY). ETFs have the lowest fees, averaging about 0.8% per annum. Some ETFs pay dividends;

#QQQ price chart for five years:

#SPY price chart for five years:

• Mutual funds. The investor buys a unit in the mutual fund portfolio (share). The composition of securities is the same as that of S&P, but their proportions may differ. The mutual fund manager may add/reduce the number of any shares at their discretion. The total amount of commissions is higher than with ETFs, as the manager’s commission is added. The average value is up to 3% per year. The most famous is the fund of the Fidelity company (market ticker – #FXAIX);

#FXAIX price chart:

• Independent purchase of shares from which the index is formed. This will require a substantial deposit. The S&P 500 index is regularly rebalanced; the shares of less successful companies are replaced with new, more successful ones. You will need to do the same in your portfolio.

In the case of ETFs and mutual funds, you can find out which stocks and in what proportion are included in the portfolio on your own.

Invest in all three indexes to make up a blue chip portfolio

In my opinion, investing in the Dow Jones, S&P 500, and NASDAQ simultaneously makes little sense. There are companies that are included in all three indices. And it is these companies that have a significant impact on each of them. Diversification will be minimal. Such an investment will be similar to investing in the same large companies in a triple amount.

The only case when this is justified is when you are learning to invest. For example, one can try investing in a NASDAQ ETF, an S&P 500 mutual fund, and independently assemble a portfolio of stocks included in the Dow Jones indices. Thus, one will get acquainted with the peculiarities of each index investment option. The risks will be low because the indices and blue chip stocks are distinguished by the smoothness of both ups and downs in prices.

Don’t forget to diversify outside of large-cap stocks

Small companies do not have a strong impact on the indices due to small capitalization and low stock prices. Therefore, investing in small cap stocks will provide diversification if you have previously invested in the Dow Jones, S&P 500, or NASDAQ.

Small company stocks are more volatile than shares of large corporations. During an economic upturn, they grow faster than the market. But they also fall faster during recessions. In addition, the probability of survival and resistance to crises in small and medium-sized businesses is lower than in large ones. Therefore, investing in such stocks is associated with increased risk.

Small companies are included in a separate index, Russel 2000.

Russel 2000 price chart:

At the initial stage, in my opinion, it is better to try investing in this index. Like other market indexes, Russel 2000 is rebalanced regularly. Therefore, there is no risk of losing your funds due to index investing in companies that may go bankrupt, weak companies will be replaced by new ones.

The Russel 2000 has its exchange traded funds:

#IWM price chart:

#VTWO price chart:

There are also mutual funds based on the Russell 2000, for example, Vanguard Russell 2000 Index Fund (trading ticker – #VRTIX):

Over a 20-year period, the Russel 2000 even outperforms the S&P 500 by nearly 0.5%. But it will have slightly deeper drawdowns since the share prices of small companies are highly volatile.

Conclusion

Investing in a large, well-known stock market index is less risky than stocks, metals, and currencies. The stocks that make up the index balance each other. Therefore, both ups and downs will be smoother. Large companies whose shares play the main role in the indices do not feature impulsive price changes. Therefore, you will hardly make incredible profits from investing your funds in a world-famous stock index. 

My recommendation is to choose one index, Dow or Nasdaq, or S&P 500. The most smooth price trends are featured by S&P 500, the most stable is Dow Jones, and the most volatile stock index is NASDAQ Composite. It is better to invest via ETFs. They charge low commissions, offer a great choice of stocks, and some even pay dividends.

To diversify index investments, you can use stocks of companies that are not included in the selected index. You can also invest in financial assets, which are not related to indices, for example, cryptocurrencies, commodities, etc.