popular indexes can make for flawed index funds the dow jones industrial average sp 500 russell 2000 and nasdaq 100 gather the lion’s share of headlines but some make better investments than others the earliest indexes were not designed to be investments each of the four us index goliaths was developed before state street launched its transformative sp 500 etf trust spy in 1993 and two before the first mutual fund tracking the sp 500 in 1976 the djia was created in 1896 as a revolutionary way to measure stock market activity the sp 500—in its current form—debuted in 1957 as a more fulsome gauge of stock market health with added breadth covering the 500 largest stocks traded on us exchanges the russell 2000 and nasdaq 100 are relative newcomers created in 1984 and 1985 respectively the former was designed as a comparator for active smallcap mutual funds and the latter was developed as a marketing engine for the burgeoning nasdaq exchange the sp 500 stands above the rest for its investment merit and investability its selection criteria require profitability and its committee decisions remain a touch arbitrary but its marketcapweighted portfolio is a welldiversified representative of the largecap us stock market you can read our full analysis of goldrated vanguard sp 500 etf voo here in this piece we examine flaws of the djia nasdaq 100 and russell 2000 as well as present some index exchangetraded fund alternatives investors should consider despite the djia’s prominence as a market gauge its age shows its bluechip ethos remains but its 19thcentury origins do not translate to a worthwhile investment offering today spdr dow jones industrial average etf dia tracks the index to near perfection but it inherits the benchmark’s flaws   the portfolio is highly concentrated with just 30 stocks and more than 50 of assets routinely allocated to its top 10 holdings   index inclusion criteria are opaque—an unnamed index committee seeks companies that have a stellar reputation and are most representative of the us economy   the portfolio is priceweighted which has no sound economic rationale and constrains the investment universe most indexes today are marketcap weighted to reflect company size more accurately   changes to the index are made on an asneeded basis with no regular review period all of the above introduce considerable active risk to what should be a passive index the process pillar rating of dia is limited to below average as a result you can read our full analysis of dia here the djia is an artifact of a different age today investors have better options available when selecting an index etf the table below highlights some highly rated alternatives source morningstar data is as of may 31 2023 the indexes behind offerings from vanguard ishares and schwab are driven by quantitative processes that systematically add and remove stocks based on investability criteria—like market cap and liquidity rather than subjective or incomplete measures all are also significantly more diversified and capture far more of the investment universe than spdr’s dia marketcap weighting and these lighttouch criteria help steer them away from the active risk incurred by dia while maintaining a representative portfolio of the us stock market invesco qqq trust qqq has compiled a track record that few can rival with its returns ranking among the top 2 of its largegrowth morningstar category peers over the trailing five 10 and 15year periods yet its benchmark the nasdaq 100 index has flaws that cast doubt on the durability of its superb performance   the index exclusively admits stocks that trade on the nasdaq exchange and spurns the rest this is driven by nasdaq’s desire to promote its exchange—not economic rationale the index denies firms like unitedhealth group unh exxon mobil xom and the home depot hd for no reason other than where they trade   only nonfinancial stocks are considered financials represent a small share of most growth strategies anyway but this narrows the index’s opportunity set   the portfolio is topheavy its top 10 holdings constituted between 49 and 59 of the portfolio over the past five years   sector concentration is a concern at the end of may about 82 of the portfolio was stashed in technology 51 communications 17 and consumer discretionary stocks 14 qqq’s robust liquidity prompts many investors to use it as a proxy for technology exposure though only about half the portfolio comprises tech stocks other investors treat it as a diversified largecap portfolio however investors use the fund better alternatives exist you can read our full analysis of qqq here the table below features tech etfs that offer cleaner exposure to the sector as well as diversified largegrowth portfolios whose broader reach and moresensible index construction makes them better allaround investments all come at a lower price too source morningstar data is as of may 31 2023 unlike the dow jones industrial average and nasdaq 100 the russell 2000 is well diversified across stocks and sectors but diversification alone is not enough to bring this bogy up to par with the best benchmarks in the smallblend category the smallcap market is a fickle beast with thousands of volatile smalltomicrocap companies populating the opportunity set unlike index competitors the russell 2000 lacks some key features to address the illiquidity inherent to its target market and mitigate its drag on fund returns   no buffer rules around its lower marketcap threshold which increases turnover and associated transaction costs   rebalances occur annually which forces funds tracking the index to concentrate rebalancing orders on one date this increases the market impact from their orders—meaning purchases will occur at increasingly high prices while sales are at decreasing prices—and the mismatch between the large orders and illiquid stocks can result in poor execution quality for funds   favors smaller stocks than some competitors with no risk control measures it may fall further than its peers when markets sour these shortcomings limit the process pillar rating of vanguard russell 2000 etf vtwo to average a low fee of 010 helps vtwo earn a morningstar medalist rating of bronze you can read our full analysis of vtwo here investors should look beyond funds tracking the russell 2000 to achieve the best outcomes indexes from crsp dow jones and sp do a better job managing risks inherent to the smallcap market and funds tracking those benchmarks earn higher process pillar ratings because of it source morningstar data is as of may 31 2023 the russell 2000 does a good job of tracking the smallcap market but is lacking as an investable product the other etfs profiled above also capture the segment well but incorporate key features like buffer rules and strict liquidity screens to make them compelling investments investors should consider one of those if seeking broad smallcap exposure the most discussed indexes don’t necessarily make the best index funds the djia nasdaq 100 and russell 2000 are frequently cited by pundits but are flawed investment products today those popular market gauges have billions of dollars tracking their every move despite lacking the modern features of indexes specifically designed with investors in mind investors should steer clear of funds tracking them the best indexes in any market segment are welldiversified and take a rulesbased approach to construction and maintenance the suggested alternatives to each flawed index track a benchmark that better manages the unique risks of each segment and incorporates operational rules that make their constituents easily investable products like vanguard total stock market etf vti ishares core sp us growth etf iusg and schwab us small cap etf scha effectively capture their target universe while controlling for unnecessary costs and risk excellent etfs like these should be on investors’ shortlist instead of those following imperfect indexes