Stock market or equity indexes are composite measurements reflecting the price movements of component stocks. Indexes are used as a benchmark to gauge portfolio performance and also serve as a barometer for overall market sentiment. When stock indexes are trending upward, it is said to be a bull market; when they trend lower, it is a bear market. In the United States, two of the most popular stock market indexes are the S&P 500 and the Russell 2000. (See also: An Introduction to Stock Market Indexes.)

The S&P 500 Index

The Standard & Poor's 500, or S&P 500 index, is an equity index comprised of 500 large-capitalization companies with stocks listed on U.S. exchanges. A large-capitalization, or large-cap, company typically has a market value greater than $10 billion. The S&P 500 is one of the most widely used benchmarks corresponding to the broader U.S. stock market. Due to its composition of 500 companies, the S&P 500 is a much broader, and perhaps accurate, measure than the popular Dow Jones Industrial Average, which contains just 30 stocks.

The S&P 500  was introduced in 1923 and took on its present form on March 4, 1957. Constituent companies are selected by a committee from S&P Dow Jones indexes, a joint venture of McGraw Hill Financial (MHFI), the CME Group (CME) and News Corporation (FOXA). The aim is to pick companies in industries and market segments that mirror the U.S. economy.

Shares are weighted by market capitalization, resulting in a cap-weighted or value-weighted index in which companies with larger market values receive a relatively greater weight. More specifically, the S&P 500 is also float-weighted, which calculates a company's market capitalization using only the number of shares available for trading by the public. This paints a more accurate picture of a firm's investable valuation. The S&P is also diverse in that it holds stocks classified as growth and also value stocks.

From time to time, the make-up of the index is adjusted to account for mergers and acquisitions, bankruptcies, special dividends, share repurchases and new share issuances. Companies may be added or removed as the landscape of the U.S. economy changes, or as companies fail to meet listing criteria, such as market valuation and financial viability.

The S&P 500 is an investable index, making it useful as a benchmark for the entire U.S. stock market. Investors and traders can replicate the S&P 500 by buying the component stocks using the same weights as the index. Accumulating positions in 500 different shares can be costly and time consuming, so alternatives exist to make investing in the index easier, including S&P 500 futures, indexed mutual funds, and indexed exchange traded funds such as SPDR S&P 500 ETF Trust (SPY). There is also an active and liquid options market on S&P 500 futures and the SPY ETF, allowing well-diversified large-cap portfolios to be hedged.

Currently, the top 10 holdings in the S&P 500 by market capitalization are: Apple Inc. (AAPL), Exxon Mobile (XOM), Microsoft (MSFT), Johnson & Johnson (JNJ), Berkshire Hathaway (BRK-B), Wells Fargo (WFC), Procter & Gamble (PG), General Electric (GE), JPMorgan Chase (JPM), and Pfizer (PFE).

Russell 2000

The Russell 2000 index, created in 1984 by the Frank Russell Company, is a stock market index comprised of 2000 small-capitalization companies. It is made up of the bottom two-thirds of the Russell 3000 index, a larger index of 3000 publicly traded companies that represents nearly 98 percent of the investable U.S. stock market.

While the S&P 500 is a suitable benchmark for large-cap portfolios, the Russell 2000 is the most common benchmark for small-cap ones. The smallest 1000 companies in the Russell 2000 make up the Russell 1000 Microcap Index. The Russell 2000 index is constructed to be representative of the smallest 2000 listed companies in the U.S. (See also: Small Caps Boast Big Advantages.)

The Russell 2000 is another market-capitalization weighted index, but it excludes certain listed stocks such as those trading below $1.00 per share, those trading on the over-the-counter (OTC) market, and companies with a market capitalization under $30 million. Unlike the S&P 500, the components of the Russell 2000 index are selected by a formula—the bottom 2000 of the Russell 3000—and not by a committee.

However, like the S&P 500, the Russell 2000 index is investable by replicating the index using component shares or through index futures, mutual funds, and exchange trading funds such as the iShares Russell 2000 index ETF (IWM). There is an active listed options market for IWM and Russell 2000 futures as well. (See also: Understanding Small- and Big-cap Stocks.)

Currently, the top 10 holdings in the Russell 2000 by market capitalization are: Isis Pharmaceuticals (ISIS), Brunswick Corp. (BC), QORVO Inc. (QRVO), TriQuint Semiconductor (TQNT), Office Depot (ODP), LaSalle Hotel Properties (LHO), Graphic Packaging Holding Co. (GPK), Puma Biotechnology (PBYI), RLJ Lodging Trust (RLJ), and Ultimate Software Group Inc. (ULTI).

The Bottom Line

The S&P 500 and Russell 2000 are both investable, market-capitalization weighted U.S. indexes that are commonly used as benchmarks by portfolio managers and investors. There are also a number of differences between the two indexes. The S&P 500 is comprised solely of large-capitalization companies and serves as the most common large-cap benchmark. Constituent stocks are chosen by a committee and contain just one-fourth of the number of companies listed in the Russell 2000. Alternatively, the Russell 2000 is an appropriate benchmark for small-cap portfolios, and member stocks are chosen by a formula and not by a committee.