A:

The S&P 500 and Dow Jones Industrial Index (DJIA) are two of the most well-known indexes tracking the movement of the U.S. market. When either of these indexes is moving up, the stock market as a whole is considered to be doing well. The return for either index is often used as a benchmark in comparing the performance of a mutual fund. Many investors over time have been unimpressed with the return of their mutual funds, compared to the return of the index or the market as a whole. This investor attitude has resulted in an increase in the number of investment products that solely track the changes in the index, providing investors with similar returns. One of the most popular of these investment vehicles are exchange-traded funds.

While the benefits of these type of funds are familiar to investors, the accuracy to which they track the index is not. The most common ETFs tracking the contents of the S&P 500 and the DJIA are Spiders, or SPDR for Standard and Poor's Depository Receipt, and Diamonds. Both of these trade on the American Stock Exchange under the symbols SPY and DIA and can be bought and sold at anytime during market hours. Both of these ETFs work on a roughly 10:1 basis meaning that if the DJIA is valued at 10,000 points corresponding to a dollar value, the DIA will be around $100. It is a rough equivalent because the ETFs are constantly traded in the market, their value will not always mirror the index. For example, it is not uncommon for the S&P 500 to be up for the day while the SPY is down. The reason for this is that the index tracks the return of the underlying stocks but is not traded. The ETF, on the other hand, is a depository receipt of the underlying stocks that the index tracks and it is traded daily. It is the trading of the ETF that causes the variation in returns with the S&P 500's. For example, if all of the stocks in the index are up during the day, the index will also be up however if investors in the ETF sell because they do not feel good about the prospects of the market looking forward, the ETF will be down. However this is not be a major concern as the divergence between the index and its ETF are relatively minor and tend to revert back to each other. The reason for this is that the underlying value of the ETF is the companies in the index itself so there is little reason for the two to vary widely.

spy.gif

The above chart illustrates the difference between the return of the SPY and the S&P 500 over a one-month period. As can be seen, the ETF (black line) actually outperformed the index (red line). However, this difference was around 0.2% as both the ETF and the index returned around 3.5% in the period. The variation between the index and ETF are considered minor and impact the substantial benefits of these investment products in no material way.

(For further reading, see Introduction to Exchange-Traded Funds and Advantages Of Exchange-Traded Funds.)

RELATED FAQS
  1. What's the difference between an index fund and an ETF?

    Learn about the difference between an index fund and an exchange-traded fund and how index fund investing compares to value ... Read Answer >>
  2. Who's in charge of managing exchange-traded funds?

    An exchange-traded fund (ETF) is a security that tracks an index but has the flexibility of trading like a stock. Just like ... Read Answer >>
  3. Is it possible to invest in an index?

    First, let's review the definition of an index. An index is essentially an imaginary portfolio of securities representing ... Read Answer >>
  4. Why can you short sell an ETF but not an index fund?

    To answer this question, we should first define exactly what an index fund is. An index fund is a mutual fund, or a basket ... Read Answer >>
  5. Should I invest in ETFs or index funds?

    Learn advantages to investing in exchange-traded funds, or ETFs, and index funds, and decide whether to include them in your ... Read Answer >>
  6. What are the advantages of an index fund over an ETF?

    Diversifying a portfolio is one of pillars of investing basics, and an index fund can provide an investor with exposure to ... Read Answer >>
Related Articles
  1. ETFs & Mutual Funds

    ETFs Can Be Safe Investments, If Used Correctly

    Learn about how ETFs can be a safe investment option if you know which funds to choose, including the basics of both indexed and leveraged ETFs.
  2. ETFs & Mutual Funds

    The Advantages of ETFs Compared to Index Funds

    With the ongoing ETF boom, ETFs gain more variety and increased competition in the market leads to further investors' advantages compared to index funds.
  3. ETFs & Mutual Funds

    ETF Tracking Errors: Protect Your Returns

    Tracking errors tend to be small, but they can still adversely affect your returns. Learn how to protect against them.
  4. ETFs & Mutual Funds

    Avoid ETFs With These Traits

    Deciding which ETFs to avoid can be as important an investment decision as deciding in which ones to invest.
  5. ETFs & Mutual Funds

    4 Ways to Evaluate ETFs Before Buying

    Learn four areas in which to evaluate an ETF investment to be sure that the investor has a clear understanding of the security being purchased.
  6. ETFs & Mutual Funds

    How To Avoid Expensive ETFs

    Discover four tips for avoiding expensive ETFs. Learn why expense ratios should be low and how to prevent your investment from costing you come tax time.
  7. Financial Advisor

    Advising FAs: Explaining ETFs to a Client

    Exchange traded funds (ETFs) have exploded in popularity with both investors and professionals for several reasons, and their growth shows no sign of slowing.
  8. ETFs & Mutual Funds

    ETF Options Vs Index Options

    Investors have much to consider when they’re deciding between ETF and index options. Here's help in making the decision.
  9. ETFs & Mutual Funds

    The Pros and Cons of Indexes

    Learn about the advantages and disadvantages of stock indexes and passive index funds. Discover how there is an opportunity cost to using index funds.
  10. Managing Wealth

    S&P 500 Vs. Dow Jones ETF: Which is a Safer Investment? (SPY,DIA)

    Learn about why the risks of investing in the ETFs that track the S&P 500 and the Dow Jones Industrial Average are very similar for investors.
RELATED TERMS
  1. Index ETF

    Exchange-traded funds that follow a specific benchmark index ...
  2. Exchange-Traded Fund (ETF)

    A security that tracks an index, a commodity or a basket of assets ...
  3. ETF Of ETFs

    An exchange-traded fund (ETF) that tracks other ETFs rather than ...
  4. Intelligent ETF

    An exchange-traded fund (ETF) that employs an active investment ...
  5. Stock ETF

    A security that tracks a particular set of equities, similar ...
  6. Index Fund

    An index fund is a type of mutual fund with a portfolio constructed ...
Hot Definitions
  1. European Union - EU

    A group of European countries that participates in the world economy as one economic unit and operates under one official ...
  2. Sell-Off

    The rapid selling of securities, such as stocks, bonds and commodities. The increase in supply leads to a decline in the ...
  3. Brazil, Russia, India And China - BRIC

    An acronym for the economies of Brazil, Russia, India and China combined. It has been speculated that by 2050 these four ...
  4. Brexit

    The Brexit, an abbreviation of "British exit" that mirrors the term Grexit, refers to the possibility of Britain's withdrawal ...
  5. Underweight

    1. A situation where a portfolio does not hold a sufficient amount of a particular security when compared to the security's ...
  6. Russell 3000 Index

    A market capitalization weighted equity index maintained by the Russell Investment Group that seeks to be a benchmark of ...
Trading Center