With the Dow approaching 13,000 again, perhaps one interesting topic for debate is whether the Dow or the S&P 500 is a better investment?
While the S&P 500 has outperformed the Dow since the market's low on Oct. 3, the Dow index posted a larger gain in 2011.
In fact, their relative performances have been mixed in recent years as well. And the indexes’ slightly different returns are likely a result of how each index is calculated.
The Dow’s price weighting methodology gives higher-priced stocks more impact. That contrasts to the S&P 500’s market cap methodology, which gives a greater weighting to bigger stocks.
Ultimately, this creates some notable disparities. Consider IBM and GE, for example, which are roughly the same size (IBM’s market cap of $226 billion vs. GE’s market cap of $199 billion), and have roughly the same 2 percent weighting in the S&P 500.
In the Dow, however, IBM has 10 times more impact than GE due to its higher price. (GE is a minority owner of NBC Universal/CNBC.)
The Dow also consists of higher dividend-paying stocks. On the flip side, the Dow 30 stocks are generally slower-growing than the S&P’s stocks.
Additionally, investors who buy the Dow or the S&P also get different exposure to certain sectors. Living up to its name, the Dow is much more heavily skewed toward industrial stocks. In contrast, the S&P provides greater exposure to financials, healthcare, utilities and tech.
While the S&P naturally provides a broader, more diversified exposure to U.S. companies with its 500 stocks, the Dow is much more narrow in scope with its mere 30 stocks. None of the stocks in the S&P has a weighting of more than 3.5 percent in the S&P 500 .
By comparison, nearly one-third of the Dow (nine of the 30 stocks) has an index weighting of more than 4 percent — making it potentially more sensitive to certain individual stock swings.
Bottom Line
Investors should understand how they’re getting different exposure to certain stocks and sectors when buying an index fund or an ETF and how that can ultimately affect their returns.
Keep in mind, very little money is indexed to the Dow, whereas over a trillion dollars is indexed to the benchmark S&P 500.
