Forget the Dow Jones — Buy this magnificent ETF instead

You’ve probably heard of Dow Jones industrial index (^DJI 1.14%). After all, it is one of the oldest stock market indices, and its ups and downs are often cited in news articles and television shows.

However, I am here to tell you that, as an investment vehicle, The Dow just doesn’t cut it out.

So let’s explore an alternative that has performed better and offers superior diversification.

Image source: Getty Images.

Comparing the Dow to the S&P 500

First, let’s compare the Dow to one of the other the most well-known stock market indices around, the S&P 500. Each index tracks the performance of a basket of stocks. For the Dow, there is 30 stocks and, unsurprisingly, the S&P 500 is tracking 500 stocks.

That in itself is a significant difference. The Dow is less diversified than the S&P 500, MEAN it is more volatile and more likely to experience large swings when a stock rises or falls dramatically.

Morethe Dow index is weighted of the price of the shares that compose it. That means they like high priced stocks UnitedHealth and Goldman Sachs — each trading at more than $500 a share — are the two Dows the biggest holdings. However, the two companies are far from the largest companies in America. UnitedHealth is the 13th largest and Goldman Sachs is the 56th largest. So while the Dow contains Apple and Microsoft (the two the biggest US companies by market capitalization), are not the Dow’s largest holdings because their share prices are lower than those of UnitedHealth and Goldman Sachs.

The S&P 500, on the other hand, is weighted by market capitalization. That’s what it means Apple, Microsoftand Nvidia are his three biggest holdings. And that was a good thing, as these tech giants have been some of the best-performing stocks over the past ten years.

Indeed, this is the biggest reason Why The S&P 500 has outperformed the Dow over the past decade.

^ DJI data by YCharts.

As shown above, the S&P 500 generated a compound annual growth rate (CAGR) of 13% over the past decade, while the Dow only managed 11.7%. And that kind of difference can matter. For example, a $250,000 portfolio invested in the Dow ten years ago would be worth about $90,000 less than the same portfolio invested in the S&P 500.

How to best invest in the S&P 500

There are many ways to invest in the S&P 500 Index. Howeverin my opinionthe best way for the average investor is through an exchange traded fund (ETF). They are cheap, accessible and easy to understand.

Among the many ETFs that mirror the performance of the S&P 500, Vanguard S&P 500 ETF (VOO 1.08%) it is a top choice. Most importantly, the fund has a long track record of closely tracking the performance of the S&P 500.

Second, the fund’s expense ratio is low — just 0.03%. While all ETFs charge fees to fund their operations, this fund keeps fees to a minimum, meaning investors keep more of their hard-earned money.

In short, due to its superior diversification, market cap weighting and performance, investors should favor the S&P 500 over the Dow Jones. What’s more, the Vanguard S&P 500 ETF offers a simple and inexpensive way to invest in the index. This is something that can make any investor happier and wealthier.