Looking at Major Stock Market Indexes

So you invest in stocks to share in the spoils of capitalistic economies. When you invest in stocks, you do so through the stock market. What is the stock market? Everybody talks about "The Market" the same way they do a close personal friend:
"The Market is down 137 points today."
"With The Market hitting new highs, isn't now a bad time to invest in The Market?"
"The Market seems ready for a fall."

When people talk about The Market, they're usually referring to the U.S. stock market. Even more specifically, they're speaking about the Dow Jones Industrial Average, created by Charles Dow and Eddie Jones. Dow and Jones, two reporters in their 30s, started publishing a paper that you may have heard of — The Wall Street Journal — in 1889. Like its modern-day version, the nineteenth-century Wall Street Journal reported current financial news. Dow and Jones also compiled stock prices of larger, important companies and created and calculated indexes to track the performance of the U.S. stock market.

The Dow Jones Industrial Average (DJIA) market index tracks the performance of 30 large companies that are headquartered in the United States. The Dow 30 includes companies such as telecommunications giant AT&T, airplane manufacturer Boeing, soda maker Coca-Cola, oil giant Exxon Mobil, automaker General Motors, technology behemoths IBM, Intel and Microsoft, fast food king McDonald's, and retailers Home Depot and Wal-Mart.

The 30 stocks that make up the Dow aren't the 30 largest or the 30 best companies in America. They just so happen to be the 30 companies that senior staff members at The Wall Street Journal think reflect the diversity of the economy in the United States. Some criticize the Dow index for encompassing so few companies and for a lack of diversity. The 30 stocks in the Dow change over time as companies merge, decline, and rise in importance.

But just as New York isn't the only city to live in, the 30 stocks in the Dow Jones Industrial Average are far from representative of all the different types of stocks that you can invest in. Here are some other important market indexes and the types of stocks that they track:

Standard & Poor's 500. Like the Dow Jones Industrial Average, the S&P 500 tracks the performance of larger-company U.S. stocks. As the name S&P 500 suggests, this index tracks the prices of 500 stocks. These 500 big companies account for nearly 80 percent of the total market value of the tens of thousands of stocks traded in the United States. Thus, the S&P 500 is a much broader and more representative index of the larger company stocks in the United States than is the Dow Jones Industrial Average.
Unlike the Dow index, which is largely calculated by adding the current share price of each of its component stocks, the S&P 500 index is calculated by adding the total market value (capitalization) of its component stocks. To impress your friends and colleagues, you can discuss with them that the S&P 500 is a capitalization-weighted index.

Russell 2000. This index tracks the performance of 2,000 smaller U.S. company stocks of varying industries. While over the longer term small company stocks tend to move in tandem with larger company stocks, it's not unusual for one to rise or fall more than the other or for one index to fall while the other rises in a given year. For example, in 2001, the Russell 2000 actually rose 2.5 percent while the S&P 500 fell 11.9 percent. Be aware that smaller company stocks tend to be more volatile.
Wilshire 5000. Despite its name, the Wilshire 5000 index actually tracks the prices of more than 6,500 stocks of U.S. companies of all sizes — small, medium, and large. Thus, many consider this index the broadest and most representative of the overall U.S. stock market.
Morgan Stanley EAFE. Stocks don't exist only in the United States. Morgan Stanley's EAFE index (EAFE stands for Europe, Australasia, and Far East) tracks the prices of stocks in the other major developed countries of the world.
Morgan Stanley Emerging Markets. This index follows the price movements of stocks in the less economically developed but "emerging" countries, which usually concentrate in Southeast Asia and Latin America. These stock markets tend to be more volatile than those in established economies. During good economic times, emerging markets usually reward investors with higher returns, but stocks can plunge farther and faster than stocks in developed markets.
Conspicuously absent from this list of major stock market indexes is the NASDAQ index. With the boom in technology stock prices in the late 1990s, CNBC and other financial media started broadcasting movements in the technology-laden NASDAQ index, thereby increasing investor interest and the frenzy surrounding technology stocks. Many experts aren't fans of sector (industry) specific investing; it undermines diversification and places you in the role of a professional money manager in having to determine when and how much to invest in specific industry groups. You might consider ignoring the NASDAQ as well as other industry-concentrated indexes.