Ask a Fool: Which Stock Index Is the Best Representation of the Entire Market?

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Q: The news headlines feature the Dow Jones Industrial Average, the S&P 500, and the Nasdaq Composite indexes. Which is the best way to gauge how the overall U.S. stock market is doing?

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Out of the three, the S&P 500 index is probably the best indicator of how the stock market is performing, but there are even better choices out there.

The Dow Jones Industrial Average only considers 30 companies, and is a price-weighted index, which places more emphasis on stocks whose share prices are high, as opposed to weighting in favor of larger companies (as most other indexes do).

The Nasdaq Composite considers nearly 3,000 stocks listed on the Nasdaq, but it's important to realize that it is a very tech-heavy index. The technology sector makes up more than 40% of the Nasdaq, but makes up only about 20% of the overall market.

Finally, the S&P 500 includes 500 stocks, and is a good representative mix of the industries that make up the overall market. Since the index includes large companies, 80% of the overall U.S. stock market capitalization is represented by the index.

However, the S&P 500 has one major shortcoming: It doesn't reflect the performance of small or midsized companies. For this reason, the S&P Composite 1500 index, which includes the S&P 500, as well as the S&P MidCap 400 and the S&P SmallCap 600, is a better representation of the overall market.

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Another good option is the Russell 3000 index, which includes twice as many stocks, and combines the Russell 1000 index of larger companies with the well-known Russell 2000 index of small caps.

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