Stock Indices: S&P 500, Dow, Nasdaq & Co.

“The S&P 500 closed up 0.8% today.” You hear that sentence every evening. But what exactly went up? Not a single stock, but an average – an index. Indices are the language markets are discussed in, and also the building blocks of index funds. If you understand them, you understand what you actually own in an ETF.

What an index is#

A stock index is a number that summarises the performance of a defined group of stocks. It answers the question: how did this market do as a whole?

The group is chosen by fixed rules. The S&P 500 contains about 500 large US companies selected by a committee; the Russell 2000 tracks 2,000 smaller US companies; the FTSE 100 the 100 largest companies listed in London. An index provider – S&P Dow Jones Indices, FTSE Russell, MSCI and others – sets the rules, reviews the members regularly and calculates the index continuously.

How weighting works – and why it matters#

An index is a weighted average. The key question is: how much does each stock count?

Market-cap weighting#

In most modern indices, each company counts in proportion to its stock market value. A company with a $3 trillion market cap has thirty times the weight of one worth $100 billion. Usually only the free float is counted – shares that actually trade, not stakes held by founders or governments.

That sounds sensible and has a big advantage: such an index mirrors how “the market” as a whole is invested. But it also has a side effect: concentration.

In 2025, the ten largest companies made up more than a third of the S&P 500 – giants like Nvidia, Microsoft, Apple, Amazon and Alphabet. If you buy “the US market”, you are to a large degree betting on a handful of technology companies. That’s not necessarily bad, but you should know it.

Price weighting: the odd case of the Dow#

The oldest US index still calculated, the Dow Jones Industrial Average from 1896, works differently. It adds up the share prices of its 30 members and divides by a divisor. A $600 stock therefore counts ten times as much as a $60 stock – regardless of how big the companies are. When a member splits its stock, its weight in the Dow drops instantly, which is why the divisor is adjusted.

Economically this makes little sense. The Dow is still famous because of its long history. For an accurate picture of the US market, the S&P 500 is the better gauge.

Price index vs. total return index#

An often overlooked difference: what happens to dividends?

• A price index only measures price changes. When a company pays a dividend, its share price drops by that amount – and so does the index. The S&P 500, the Dow, the Nasdaq-100 and the FTSE 100 as quoted in the news are price indices.
• A total return index assumes all dividends are reinvested immediately. It shows what an investor would actually have earned. Germany’s DAX is unusual in being quoted this way by default.

So when someone says “the S&P 500 returned X% this year”, check whether they mean price or total return. As an ETF investor you get the total return, because your fund actually receives the dividends.

Indices aren’t laws of nature#

People build indices according to rules, and those rules have consequences:

• Promotions and relegations: Growing companies join the index, shrinking ones are dropped. An index therefore has a built-in tendency to rotate into winners. Today’s S&P 500 has little in common with the one of 50 years ago.
• Country and sector tilts: The Nasdaq-100 is dominated by technology, the FTSE 100 by banks, energy, miners and consumer staples. And despite its name, the MSCI World contains no emerging markets such as China, India or Brazil – and is about 70% US.
• Index effects: When a stock is added to a major index, index funds must buy it. That can push the price up temporarily.

What indices mean for you#

Indices matter to investors for two reasons:

1. As a benchmark: A fund that invests in large US companies has to measure itself against the S&P 500. If it fails to beat the index after costs over many years – and the large majority of actively managed funds do fail – its management fee wasn’t worth paying.
2. As an investment: An ETF tracks an index, usually at very low cost. With a single S&P 500 ETF you own a slice of around 500 companies. Module 2 explains how that works.

Summary#

An index summarises a market in one number. Most are weighted by market value, so big companies set the tone. The Dow and the Nikkei are price-weighted – a relic. Whether dividends are included makes an enormous difference over time. And because indices are built by rules, it always pays to look at what’s actually inside – especially before buying an ETF on one.