The Dow Jones Industrial Average Index is among the oldest stock indexes, while the S&P 500 is the most tracked index globally. Investing in passive ETFs and index funds gained traction. Most active funds had dismal returns despite their higher fee structure. Between the Dow Jones and the S&P 500 ETF, which should you choose for your portfolio?
What is the best way to invest in blue-chip stocks?
There are three ways to invest in blue-chip stocks. First, you can buy individual stocks of blue-chip companies. Second, you can invest in an active mutual fund whose mandate is to invest in blue-chip stocks. Third, you can invest in an ETF that tracks an index like the S&P 500, the Dow Jones, or the Nasdaq 100 Index.
Each strategy has pros and cons. If you invest in individual stocks, you will have to do research and continuously monitor your investments. In an active mutual fund, you will also have to monitor the performance. Most of the active mutual funds have fared worse than their benchmark. If you go for an index fund or an ETF, you will have to decide which index you want to mimic.
Looking at the performance in 2020, the Nasdaq is the best performing index due to tech stocks’ outperformance. The S&P 500 is also positive for the year, while the Dow Jones is still negative for 2020. The Dow Jones briefly turned positive for the year in August. However, you shouldn’t base your decision on short-term returns. Investors should look at the larger picture.
Is the Dow Jones or the S&P 500 better?
In order to choose between the Dow Jones and the S&P 500, there are a few aspects to consider. First, the S&P 500 is more diversified with the 500 biggest U.S. companies, while the Dow Jones only has 30 constituents.
Second, the S&P 500 is a market cap weighted index, while the Dow Jones is a price-weighted index. In a price-weighted index, the constituent's price determines its weight in the index. In a market capitalization weighted index, the constituent’s weight is a function of its market capitalization. In August, the Dow Jones had to rejig the index since Apple’s stock price fell after the split. While market capitalization and a price-weighted index have their own sets of pros and cons, the market cap weighted index is generally better.
Looking at the returns, over the last year, the S&P 500 has outperformed the Dow Jones by 9.3 percent. If we extend the period, the S&P 500 has outperformed the Dow Jones over a five year and 10-year period by 1.7 percent and 36.7 percent, respectively.
The S&P 500 is the most popular index globally with over $4.6 trillion of assets indexed to it. The S&P 500 is diversified and a better indicator of the U.S. economy than the Dow Jones. The S&P 500 scores over the Nasdaq index, which is overweight in the tech sector. While the Nasdaq is up in double digits this year, it doesn't really reflect the overall state of the U.S. economy and stock markets. You can choose from any of the best S&P 500 ETFs to get exposure to the index.
Warren Buffett, Berkshire Hathaway's chairman, also advocates investing in S&P 500 ETFs. At this year's shareholder meeting, Buffett said, “Get a cross-section. And in my view, for most people, the best thing to do is to own the S&P 500 index fund.” Berkshire Hathaway also owns S&P 500 ETFs. In the fourth quarter of 2019, Berkshire Hathaway brought shares in the SPDR S&P 500 ETF and the Vanguard S&P 500 ETF.