Two of the oldest and best known exchange-traded-funds (ETFs) are the one that tracks the Dow Jones Industrial Average (Diamond Trust [DIA], “diamonds”) and the one that tracks the S&P 500 (S&P Deposit Receipts [SPY], “spiders”). These instruments track the mostly widely watched U.S. stock indexes. Each has strengths relative to the other that you should consider before investing.

Diamonds (DIA)

The Dow Jones Industrial Average is comprised of 30 large cap stocks that are thought to represent the broad market. Most retail investors watch this index, and it is the one you will be most likely to hear referred to by the popular press. DIA is very liquid, trading over 10 million shares per day on average, so you should have no difficulty either entering or exiting this instrument when you choose. As an alternative to buying a mutual fund that tracks the Dow, DIA is a good option.

Spiders (SPY)

The S&P 500 is comprised of 500 of the largest companies that are publicly traded in the United States. This is the index that is most watched by professional traders, so if this makes a difference to you, SPY would be a better option than DIA. This index will tend to act more rationally and in line with the broad market because professional traders are driving performance. In other words, the S&P 500's behavior is driven by the forces of professional traders, while other indexes are more heavily influenced by less experienced market participants. Furthermore, because professionals trade futures as well as stocks, the volume of trades that are made directly in the index is much higher for the S&P 500 than for the Dow.

SPYs are extremely liquid, currently averaging over 166 million shares per day. As with DIA, you should never have any difficulty either entering or exiting a SPY trade, but in case of extreme market activity, SPYs are more liquid. During a crash, for example, the increased liquidity of SPY might be preferable, but with the level of liquidity for each, you will probably never notice a difference.

Advantages

The area in which SPY most greatly surpasses DIA is in its ability to represent the broad market accurately. The S&P 500 has 500 stocks that are weighted by market cap, meaning that larger companies have a bigger effect on the index. The Dow, which is made up of only 30 stocks, is price weighted, meaning that more expensive stocks have more impact-–the price of the stock rather than the size of the company drives the importance of the stock in the index.

Furthermore, because there are only 30 stocks in the Dow, on days in which those companies experience significant activity-–like earnings announcements, for example-–the index may appear to move more than the market as a whole. The 500 stocks in the S&P mean that it is even less likely that the activity of a few stocks can have an impact on the index unless they affect the whole market. When you are considering which ETF to buy to represent the broad market, SPYs are usually a better choice. DIA has its place, and there is no rule saying you cannot invest in both.

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