It could say a lot about the state of the bull market

The S&P 500 Index and the Dow Jones Industrial Average are two of the most widely-followed stock market indexes. And, while they have some very clear differences in their DNA, they tend to perform in sync much of the time. In fact, over the past 10 years, including dividends, the S&P 500 has beaten the Dow by a total of only 5%. That’s not much over a full decade.

Interestingly, all of that performance difference has come in the last 10 months. That is, the S&P 500 has returned 5% more than the Dow since the start of last March. This is one of those things that likely skips right past many investors, since they tend to think of “the market” as one big collection of stocks.

However, since these 2 indexes make up a very large percentage of the total U.S. stock market, it pays to understand the basics of how they are different. Furthermore, when one is doing much better than the other, as has been the case the past 10 months, it can help to understand why. Often, it is little, easily overlooked cues that help us prepare for the times ahead.

What’s the difference?

The S&P 500 and the Dow are both overseen by committees that determine which companies are in the index at any time. Changes tend to be infrequent. The S&P 500 ends up holding what are roughly the largest 500 stocks according to their “market capitalization” (the number of outstanding shares multiplied by the price). The S&P tends to reward larger companies and past winners, since it is weighted by relative size of the stocks.

The Dow is only 30 stocks, and those stocks are subject to a funky weighting based on the dollar price of each stock. I will spare you the details, but suffice it to say that this makes the Dow a lot quirkier than the S&P 500, even though the Dow contains 30 mega-sized leading U.S. businesses.

The biggest differences I have noticed in recent years is that the S&P 500 has been powered higher by the stocks that pay little or no dividends. The Dow does not have any 0% dividend yielders. As a result, the S&P 500 tends to be growthier than the Dow. Since the past year has been more about growth stocks and particularly those in the tech sector, that has accounted for much of the gap in returns.

The other important aspect is that off-beat price weighting that defines the Dow. As of this time last year, Boeing had the highest dollar price attached to its stock of any Dow component. That made it the largest weighting in the Dow, over 10% at one point. Boeing’s stock has slumped thanks to the Max Jet fiasco. That has helped keep the Dow behind the S&P 500, which does not have any stock near that weighting level.

How many stocks to own?

Going forward, these details are not the key takeaway. What is? That you understand what you own! I personally like holding about 25-30 individual stocks in a portfolio. If you get much beyond that, you might as well opt for the convenience of ETFs.

In addition, weighting your own portfolio of stocks by market capitalization or stock price, as the S&P 500 and Dow do respectively is not typical unless you are running an index fund (in which case you mimic the index as a rule). So, for these reasons and many others, I think investors pay too much attention to the S&P 500 and Dow Jones Industrial Average as indicators of how they should be doing.

What you can learn from the S&P 500 and Dow

In summary, the S&P 500 and Dow are popular indicators of stock market performance. But I think a better reason to understand them goes way beyond just seeing how they performed. If you look inside what makes them tick, it can help you understand better which parts of their makeup you want to include in your portfolio, and which you don’t. After such a strong period for the S&P 500 versus the Dow, this will a key to not getting fooled by recent events.

Comments provided are informational only, not individual investment advice or recommendations. Sungarden provides Advisory Services through Dynamic Wealth Advisors