The DOW Jones And S&P 500 Explained

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The DOW Jones And S&P 500 Explained

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Stock reports invade your daily news cycle. For radio listeners, it’s a rapid-fire attack on the “fives” along with weather and traffic. As the long-time host of Money Matters on WSB radio in Atlanta, I’ve heard enough stock reports to fill a book. In fact, I’ve written two.  

Despite the barrage of information about the Dow Jones and the S&P 500, here’s the extent of what most folks retain: up is good, down is bad. And that’s okay. There’s nothing wrong with being too busy working or raising a family to know the difference between exchange-traded funds and real estate investment trusts or the latest perspective on the inverted yield curve. If everyone were an investment professional, I’d be out of a job.

What do stock reports and updates mean for you and your retirement planning? 

To wit, the time feels suitable for a refresher course. There’s no shame in brushing up on the basics of your financial narrative, so let’s focus on two main characters: the Dow Jones Industrial Average and the S&P 500. 

The Dow Jones Industrial Average

The Dow Jones Industrial Average (DJIA or the Dow) is a basket of thirty U.S. companies, all highly significant to the US economy. The Dow, as it’s often called, is a price-weighted average of these thirty companies and a scoring system of the sum of their share prices. 

The Dow is a scaled average and a scoring system of the sum of the share prices of the 30 American companies that make up the Dow. The Dow number changes every day because of the daily price movements of these 30 equities. This scaled average is technically a derivative of price, and not primarily based on market capitalization (more on that in our discussion of the S&P 500). At its core, it is an expression of share price in dollars.

Furthermore, because the Dow is an expression of price in dollars, it also measures the relative price tag of each stock.  For example, regardless of overall market cap (or company size), a Dow stock trading at $300/share has much more weight on the index than a Dow stock that trades at $50/share.  So, each Dow point represents a scoring system that first looks at price. 

Secondarily, because the price of a stock impacts a company’s total size (market cap), the Dow’s scoring system in a way also measures overall market cap, but with a greater emphasis on a company’s relative share price. The Dow number changes daily because of the price movements of these thirty equities, hence all the focus on what the Dow is doing today. This scaled average is technically a derivative of price and not based on market capitalization. As a reminder, market capitalization refers to the total company worth calculated by multiplying the number of outstanding shares by the current price of one share.

The formula for the Dow adds all thirty share prices together and then divides that sum by a moving divisor that accounts for stock splits, dividends, and spinoffs (a type of stock divestiture). Each resulting point level for the Dow is essentially an odometer reading or price tag representing a dollar value for the basket of the thirty stocks. In other words, if it were a basket of fresh apple varieties, each point level would represent the dollar value of that basket rather than the individual price of a Honeycrisp, Gala, Pink Crisp, or Red (not-so)Delicious.  As an apple connoisseur, I can never resist taking a shot at the highly overrated red apples that dominated my youth.

So, a point on the Dow represents dollars and cents, but the worth of one Dow point is a bit of a moving target. Here’s a good approximation. Divide one by the current Dow figure and multiply that by the total Dow market capitalization:

1/Dow x Total Dow Market Cap

Selecting actual numbers from September 30, 2022 (Source: Bloomberg) for the sake of example, we get:

1/28,725 x $9.0 trillion = $313 million

Here, one Dow point equals just over $300 million in value or company market cap.

Again, the overall moves in the Dow are based on its component companies’ share prices, which means that stocks trading at a very high level can have a disproportionately substantial impact on the overall Dow number.

Investment bank Goldman Sachs, for example, has a market cap of about $100.0 billion and trades at around $293.05 a share. As another example, Apple (the technology company, not the fruit) has a market cap of $2.2 trillion but trades at “just” around $138.20 per share. So, if Goldman has a rough day and loses 10 percent of its share value, the Dow will feel that pain more sharply than if Apple suffers a similar setback. Despite a market cap of $105.8 billion, Intel, for context, would have to experience wild movement to seriously impact the Dow, as it trades at around $25.77 a share.

Because the Dow incorporates a diverse group of trusted companies to compile its index, investors rely on the findings to gauge how the overall market is performing. This trust informs daily buying and selling decisions, which affects future market movement. 

The S&P 500

Like the Dow, the S&P 500 is also an index. Conceptually, it’s made up of five hundred stocks selected by economists to represent the performance of the top large-cap companies in America. It’s a scoring system. However, instead of using price as a primary measure, the S&P 500 uses company size to determine what components have the most significant impact. This distinction brings about the term “cap-weighted” that you may have heard during a stock report. 

The S&P 500 is a scoring system that measures size (market cap) in dollars. Each S&P point measures the underlying market capitalization of these 500 US stocks. To measure or calculate the S&P 500, we take the sum of the market capitalization of the 500 component companies and divide them by another floating divisor. Like the Dow, this divisor fluctuates to accommodate stock splits, special dividends, and spinoffs. Currently, the divisor is somewhere near $8.4 billion.

At its essence, an S&P point represents a unit of market size or value — meaning a measure of the market capitalization in dollars. So, what’s an S&P 500-point worth? Let’s do the math. 

We use the same formula as we did with the Dow, which gives us the following:

1/S&P 500 Price x Total S&P 500 Market Capitalization

Selecting actual numbers from September 30, 2022 (Source: Bloomberg) for the sake of example, we get:

1/3,585 x $30.1 trillion = $8.4 billion

And there we have it. One S&P 500-point equals almost $8.4 billion worth of company size or dollar value. Because the S&P 500 considers only market capitalization (unlike the Dow), you won’t be surprised to learn that companies like Apple have a lot of sway in this figure.

I do apologize for all the math. Unfortunately, it’s the best way to explain these two crucial stock market indicators practically. It is critical to your long-term investment strategy and overall retirement plan to know what’s behind the numbers that define the stock market’s current state and history.

Do you need news updates about the Dow and S&P 500 every fifty-five minutes to avoid financial doom in retirement? 

In my opinion, no. But don’t tell my program director I said that because it helps me transition between segments. In reality, the happiest retirees pick a smart investing strategy and stay the course despite the market’s daily volatility. I suggest paying attention responsibly but not obsessively. 

Some folks do the research and execute trades on their own, but it often helps to get tips from an advisor. Statistics show that about 30 percent* of investors go it alone, while 70 percent seek the advice of investment professionals. This factoid may sound like a plug for Capital Investment Advisors, but there are plenty of good ones out there. Find an informed, objective, trustworthy advisor that you connect with and feel comfortable discussing your plans for a happy retirement.   

Many retirees are happier leaving the financial tick-tock to the professionals. Spending time with your family and investigating the newfound joys of retirement freedom is more fulfilling. Of course, stock reports have their place. Just make sure they stay in their lane. 

*https://www.cnbc.com/2022/06/15/most-millennial-millionaires-believe-economy-will-improve-by-year-end.html#:~:text=While%20nearly%2070%25%20of%20millionaires,have%20higher%20amounts%20of%20cash.

This is provided as a resource for informational purposes and is not to be viewed as investment advice or recommendations.  This information is being presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. The mention of any company is provided to you for informational purposes and as an example only and is not to be considered investment advice or recommendation or an endorsement of any particular company.  Past performance is not indicative of future results. Investing involves risk, including the possible loss of principal. There is no guarantee offered that investment return, yield, or performance will be achieved.  The information provided is strictly an opinion and for informational purposes only and it is not known whether the strategies will be successful. Investment decisions should not be made solely based on information contained herein. There are many aspects and criteria that must be examined and considered before investing.  This information is not intended to, and should not, form a primary basis for any investment decision that you may make. Always consult your own legal, tax, or investment advisor before making any investment/tax/estate/financial planning considerations or decisions.  The views and opinions expressed are for educational purposes only as of the date of production/writing and may change without notice at any time based on numerous factors, such as market or other conditions.

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