A Few Points About Index Points
As we covered in our last piece, indexes have their uses. They can roughly gauge the mood of a market and its participants. If you’ve got an investment strategy that’s designed to capture that market, you can see how your strategy is doing in comparison … again, roughly. You can also invest in index funds that tracks an index that tracks that market. This may help explain why everyone seems to be forever watching, analyzing and talking about the most popular indexes and their every move. But you may still have questions about what they are and how they really work. For example, when the Dow Jones Industrial Average (the Dow) exceeded 20,000 points last January, what were those points even measuring?
An index’s total points represent a relative value for the market it is tracking, calculated by continually assessing that market’s “average” performance.
If that’s a little too technical for your tastes, think of it this way: Checking an index at any given time is like dipping your toe in the water to see how the ocean is doing. You may have good reasons to do that toe-check, but as with any approximation, be careful to not misinterpret what you’re measuring. Otherwise, you may succumb to misperceptions like: “The Dow is so high, it must be in for a fall. I’d better get out.”
With that in mind, when it comes to index points, we’d like to make a few points of our own.
Indexes Are Often Arbitrary
It helps to recognize how popular indexes become popular to begin with. In our free markets, competitive forces are free to introduce new and different structures, to see how they fly. In the same way that the markets “decided” that the iPhone would prevail over the Blackberry, popular appeal is effectively how the world accepts or rejects one index over another. Sometimes the best index wins and becomes an accepted reference. Sometimes not.
Measurements Vary
Different indexes can be structured very differently. That’s why the Dow recently topped 20,000, while the S&P 500 is hovering in the 2,000s, even though both are often used to gauge the same U.S. stock market. The Dow arrives at its overall average by adding up the price-weighted prices of the 30 securities it’s tracking and dividing the total by a proprietary “Dow divisor.” The S&P 500 also takes the sum of the approximately 500 securities it’s tracking … but weighted by market cap and divided by its own proprietary divisor.
S&P 500 vs. Nasdaq Composite: How Do They Stack Up?
Now, let’s address another common point of confusion: How does the S&P 500 compare to the Nasdaq Composite Index?
While both are prominent benchmarks in the U.S. Market, they take very different paths to measure performance. The S&P 500 is more like a wide-angle lens, capturing 500 of the country’s largest publicly traded companies from a broad mix of sectors—think everything from healthcare to finance to technology. Its goal: to offer a sweeping snapshot of corporate America as a whole.
On the other hand, the Nasdaq Composite aims its spotlight much more on innovation. It casts a much wider net in terms of sheer numbers (nearly 3,000 stocks!), but with a tech-forward twist. You’ll find the darlings of Silicon Valley and a larger share of younger companies here, which can make for a bumpier ride. The Nasdaq tends to be more volatile, often surging higher—or lower—than its broader cousin, the S&P 500.
So, while both indexes regularly make headlines and can move in similar directions, keep in mind: the S&P 500 is widely seen as a temperature gauge for the overall U.S. Market, whereas the Nasdaq Composite can give a more amplified read on sectors like technology and growth stocks.
Who Maintains the S&P 500?
Speaking of how indexes are built, you might wonder who actually decides which companies make the cut for the S&P 500. That job falls to S&P Dow Jones Indices, a subsidiary of S&P Global. They keep a close watch on the index, routinely reviewing—and sometimes shuffling—the lineup to ensure it captures a representative snapshot of the U.S. stock market. If a company no longer fits the bill or a new heavyweight emerges, adjustments are made to keep the S&P 500 up to date.
How Does the S&P 500 Compare to the Russell 1000?
Now, if you’ve ever wondered how the S&P 500 stacks up against the Russell 1000, you’re not alone. These two indexes are frequently mentioned in investment conversations, but they serve slightly different purposes—think of them as two different maps of the same landscape, each telling a slightly different story.
The S&P 500 zooms in on—you guessed it—about 500 of the largest U.S. Companies, spanning a broad range of industries but staying focused on large, established names. It’s the market’s way of taking the temperature of big businesses in America.
Meanwhile, the Russell 1000 takes a wider-angle snapshot. Instead of stopping at 500, it goes on to include the next 500 or so sizable companies as well—capturing both large and mid-sized players. This means the Russell 1000 covers nearly the top half of the whole U.S. Stock market by size, giving you exposure to a broader mix, while the S&P 500 sticks to the upper crust.
To put it simply:
S&P 500: Focused report card for the largest 500 U.S. Companies.
Russell 1000: Inclusive mix of the top 1,000, expanding the roster to capture more of what’s happening across the market’s biggest and mid-sized companies.
Which is “better” depends on what you’re after. If you want a snapshot of the true giants, the S&P 500 does the trick. If you’d like a bit more breadth—without getting into the weeds of tiny companies—the Russell 1000 might feel more comprehensive. Either way, both give you solid tools for tracking and comparing big slices of the U.S. Equity market.
What Kinds of Companies Make Up the S&P 500?
You might be picturing a gathering of blue chip giants, and you wouldn’t be far off—but the S&P 500 is a bit more nuanced than a “who’s who” of Wall Street. The companies housed within this index are, in essence, the corporate heavyweights of America. To qualify, a business needs to be among the largest (by market capitalization), publicly traded, and exhibit ample liquidity—think companies whose shares are frequently bought and sold on major U.S. stock exchanges.
But here’s the real trick: this isn’t a club limited to any one industry. The S&P 500 strives for broad representation across the business world. So you’ll find tech titans, big pharma, industrial stalwarts, financial institutions, consumer goods makers, energy conglomerates, and even companies driving trends in communications and healthcare. In other words, it’s a cross-section of the sectors that keep the U.S. economy running.
A committee reviews and updates the roster from time to time, adding companies that have grown in size or significance and removing those that no longer fit the bill. At any given moment, the lineup may shift, but the overarching goal remains the same: offering a snapshot of how leading American businesses—spanning almost every corner of the marketplace—are performing together.
With mysterious divisors, terms like “price-weighted” and “market cap,” and additional details we won’t go into here, this probably still doesn’t tell you exactly what index points are. Think of index points as being like thermometer degrees. Most of us can’t explain exactly how a degree is calculated, but we know hot from cold. We also know that Fahrenheit and Celsius both tell us what the temperature is, in different ways.
How Does a Company Get Included in the S&P 500?
You might also be wondering: what does it take for a company to snag a spot in the S&P 500? Entry isn’t as simple as buying a golden ticket—or even just being a sizable business.
Instead, inclusion is overseen by a committee at S&P Dow Jones Indices, who weigh a mix of eligibility factors. Here’s the basic recipe:
Location matters: The company must be U.S.-based.
Size counts: It needs to have one of the largest market caps among American companies—think top 500 contenders in terms of value.
Financial stability: Typically, positive earnings over the previous four quarters are a must, although there’s some wiggle room for special cases, like certain real estate investment trusts.
The committee regularly reviews the roster and may shuffle constituents to best reflect the overall U.S. Stock market. So when you see a new name pop up in the S&P 500, it’s usually because they’ve crossed those high bars for size and financial soundness—not just because they’re making headlines.
With mysterious divisors, terms like “price-weighted” and “market cap,” and additional details we won’t go into here, this probably still doesn’t tell you exactly what index points are. Think of index points as being like thermometer degrees. Most of us can’t explain exactly how a degree is calculated, but we know hot from cold. We also know that Fahrenheit and Celsius both tell us what the temperature is, in different ways.
Same thing with indexes. You can’t directly compare an S&P 500 point to a Dow point; it doesn’t compute. Moreover, neither index adjusts for inflation.
A Look at S&P 500 Returns: The Recent Record
So how has the S&P 500 actually performed in recent decades? Let’s take a quick dip into the numbers pool:
Over the past 20 years, the S&P 500 has climbed by roughly 309%.
Looking at just the last 10 years, it’s up about 135%.
And in the most recent 5 years, the index has gained approximately 56%.
Keep in mind, these figures represent cumulative returns and do not account for inflation. They also reflect the ups, downs, and zig-zags of the market along the way.
These returns can offer perspective on potential growth, but they’re historical—and, as the well-worn saying goes, past performance isn’t a guarantee of what’s to come. You may see hypothetical projections that use an average annualized return (for example, about 9.6% from 1982 to 2022), but those are just tools for illustration, not crystal balls for prediction.
So, while index values offer a relative sense of how “hot” or “cold” a market is feeling at the moment, they can’t necessarily tell you whether a market is too hot or too cold, or help you precisely predict when it’s time to buy or sell into or out of them. The “compared to what?” factor is missing from the equation. This brings us to our third point …
Some Drawbacks of the S&P 500
While the S&P 500 is often touted as the classic benchmark for U.S. Large-cap stocks, it comes with its own set of quirks and caveats that investors should keep in mind.
First, because the S&P 500 is market-cap weighted, it tends to lean heavily toward the biggest names—think Apple, Microsoft, and Google’s parent company, Alphabet. This means the performance of just a handful of giants can drive much of the index’s returns, while hundreds of smaller companies in the index barely make a ripple. As a result, rising stars or smaller, fast-growing firms may be underrepresented, limiting your exposure to those potential growth stories.
Another important consideration: the S&P 500 isn’t immune to sector clusters. If a particular sector—say, technology or healthcare—is flying high, the index can become concentrated in that area. This can leave you more exposed if those sectors take a turn for the worse, rather than spreading your risk evenly across the economy.
And a final footnote—like most indexes, the S&P 500 doesn’t filter for overvalued areas of the market. If a sector or group of stocks is bubbling up faster than their fundamentals can support (remember the dot-com days?), the index will simply mirror those inflated prices rather than steering around them.
In short, while the S&P 500 offers a useful snapshot of U.S. Stock performance, it isn’t a flawless indicator. Understanding these built-in limitations helps you see the full picture—and remember to take every index reading with a pinch of salt (not just a toe in the water).
Models Are Approximate
There’s an important difference between hard sciences like thermodynamics and market measures like indexes. On a thermometer, a degree is a degree. With market indexes, those points are based on an approximation of actual market performance – in other words, on a model. A model is a fake copy of reality, with some copies rendered considerably better than others. Here’s what Nobel Laureate Eugene Fama has said about them: “No model is ever strictly true. The real criterion should be: Do I know more about markets when I’m finished than I did when I started?”
Your Take-Home
According to Professor Fama’s description of a model, indexes have long served as handy proxies to help us explore what is going on in particular slices of our capital markets. But, they also can do damage to your investment experience if you misinterpret what they mean. For now, remember this: An index’s popular appeal is the result of often-arbitrary group consensus that can reflect both rational reasoning and random behavioral bias. Structures vary, and accuracy is (at best) approximate. Even the most familiar indexes can contain some surprising structural secrets. In our next post, we’ll unlock some of them for you.