Ask A Fool: What's the Difference between the Dow Jones Industrial Average and the S&P 500?

By Matthew Frankel Markets Fool.com

Q: What's the difference between the Dow Jones Industrial Average and the S&P 500?

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The Dow Jones Industrial Average, or Dow, is perhaps the most well-known stock index in the world, and milestones achieved by the index, such as the recent market rally to "Dow 20,000," are closely watched by the media. However, the S&P 500 is a far better indicator of how the stock market is doing.

The Dow has two major flaws that investors should be aware of. First, it only considers the performance of 30 companies -- hardly a good representation of the 5,000+ NYSE- and NASDAQ-listed stocks.

Second, the Dow is a price-weighted index, which means that higher-priced stocks have more influence on the index's performance than lower-priced ones. For example, at about $230 per share, Goldman Sachshas more than seven times the impact on the Dow's performance as General Electricat about $30 per share, even though General Electric is nearly three times its size, by market cap.

On the other hand, the S&P 500 considers 500 large companies as the name implies -- almost 17 times as many as the Dow. More significantly, the S&P 500 is a market cap-weighted index, meaning that larger companies have more influence over the index than smaller ones.

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Matthew Frankel owns shares of Goldman Sachs. The Motley Fool owns shares of General Electric. The Motley Fool has a disclosure policy.