E Know Your Indexes

Last year the Dow Jones Industrial Average gained 25 percent and it outperformed most stocks. Why so strong? The Dow is price-weighted so high-priced stocks like Boeing (currently $350) play a large role. Because of its high price, Boeing represents eight percent of the Dow. Since Boeing rose 90 percent in 2017, that one stock added 7 percent to the Dow’s return. Without Boeing, the Dow would have been up about 18 percent, which is closer to the S&P 500’s overall return.

While the Dow is price weighted, the S&P 500 is capitalization weighted. The greater a company’s market value, the bigger the role it plays in the index. The five largest stocks are Apple, Microsoft, Amazon, Facebook, and Berkshire Hathaway. Those five represent 12 percent of the index. Compare that to the five smallest stocks in the index, which combined represent less than 1 percent of the S&P index.  

The movement of a capitalization-weighted index can be quite different from one in which each stock is equally weighted.  While the S&P 500 rose 19.4 percent in 2017, the Guggenheim S&P 500 Equal Weight ETF (RSP) rose 16.6 percent. With RSP, each S&P 500 stock is equally important so its return is a better reflection of the market. 

Still, the S&P 500 holdings are mostly large-company stocks so a case can be made that the S&P 500 really represents large-cap stocks instead of the entire market. Mid-caps are barely represented. In 2017, large-caps did best. The S&P 400 Mid-Cap Index rose 14.5 percent and the Russell 2000, a measure of small company stocks, rose 13 percent. 

While most market measurements are price weighted or cap weighted, you can purchase “smart beta” ETFs that place importance on factors that might lead to better performance. For example, the ProShares S&P 500 Aristocrats ETF (NOBL) holds the stocks in the S&P 500 that have increased their dividends for at least 25 consecutive years. To move beyond just the S&P 500 stocks, consider Vanguard Dividend Appreciation ETF (VIG ). It holds companies (even ones outside of the S&P 500) that have increased their dividends for at least 10 consecutive years.

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Disclaimer: David Vomund is a fee-only money manager. Information is found at vomundinvestments.com or by calling 775-832-8555. Clients hold the ...

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