Ask a Fool: Why Is the S&P 500 Used as a Benchmark for Performance So Often?

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Q: The Dow Jones Industrial Average is the number that usually makes the headlines, but more investors seem to compare their performance to the S&P 500. Why?

The Dow Jones Industrial Average is certainly the attention-grabbing stock index. It's been around since the 1800s, and with the highest numbers of the three top indexes (Dow, S&P 500, Nasdaq), it makes for more exciting headlines. This is why it was much more publicized when the Dow crossed 25,000 for the first time than when the S&P 500 surpassed 2,500, for example.

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However, the Dow simply isn't a great representation of the overall stock market. For starters, the index only includes 30 companies, so it's just a small cross-section of the thousands of companies in the market.

The Dow is also a price-weighted index, meaning that higher-priced stocks count more, even if they represent smaller companies. For example, Goldman Sachs, with a share price of about $230 has roughly five times the influence on the index as $48-per-share Verizon Communications, even though Verizon is more than double the size of Goldman.

On the other hand, the S&P 500 includes 500 companies that combine to represent about three-quarters of the stock market in terms of market capitalization. And, the S&P 500 is a market cap-weighted index, meaning that the larger companies have more influence over the index.

In short, the S&P 500 is a much better representation of the overall stock market, which is why it's the benchmark that so many investors and fund managers compare their performance against.

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Matthew Frankel has no position in any of the stocks mentioned. The Motley Fool owns shares of VZ. The Motley Fool has a disclosure policy.