Cosa è un indice?
The market is up, the market is down. Every night we hear about the stock markets on the news, radio, and in the paper. What does it mean when they say the markets are up? If they are up 100 points does that mean $100? Sometimes.
Today, words like Dow, S&P,
and Nasdaq are a part of our everyday vocabulary. Lets take a look at
what an index is and then tour though some of the major stock indexes
we hear about everyday.
What is an Index?
The first and consequently most widely known index was created back on May 26, 1896 by Mr. Charles Dow. At that time the Dow index contained 12 of the largest public companies in the U.S.. Today, the Dow Jones Industrial Average (DJIA) contains 30 of arguably the largest and most influential companies in the U.S. and world economy. We will discuss the composition of the DJIA later in this tutorial.
The basic definition of an index is "a statistical measure of the changes in a portfolio of stocks representing a portion of the overall market".
Before the computer age, calculating the price of a stock market index had to be kept as simple as possible. The original DJIA was calculated by adding up the prices of the 12 companies and then dividing that number by 12. These calculations were actually more like an average than an index, but it served its purpose.
Today computers do most of the work and the indexes are much more accurate to the market. For example, many of the larger indexes now are based on the market capitalization of a company's stock rather than the stock price alone.
Each stock index is slightly different. They include different types and amounts of stock. Some are even calculated in a slightly different manner to portray a different statistical measure.
Let's take a look at some
of the more popular stock indexes.
The Dow Jones Industrial Average
Today, the Dow Jones Industrial Average (DJIA) contains 30 of the largest and most influential companies in the U.S. and world economy. It is hands down the most well known index in the world, and the only one that is constantly referred to as "the market".
Charles Dow on May 26, 1896
Advantages: The DJIA has weathered
the test of time. It contains 30 of the largest (blue chip) companies
in the world therefore it is not considered to be volatile or risky.
The Standard & Poors 500 Index
As we just mentioned, the main problem with the DJIA is that it only contains 30 companies. The S&P 500 attempts to fix that problem by including 500 companies. As a result the index includes over 2/3 (at time of writing) of U.S. market capitalization. More and more, it is being considered to be the benchmark of the U.S. stock markets. Furthermore when mutual funds state that they have outperformed the market they are usually referring to the S&P 500.
Standard and Poor's Index Services
Advantages: The S&P 500
is one of the best benchmarks in the world. By containing 500 companies
is has great diversification. The performance of the S&P 500 is
considered one of the best overall indicators of market performance
and mutual fund manager's goal is to beat it.
The NASDAQ Composite Index
Similar to the S&P 500, the NASDAQ Composite Index includes a wide range of companies. The recent surge in popularity for technological stocks has launched the NASDAQ into the spotlight and the composite index is arguably one of the most followed indexes in the world.
NASD in 1971
Advantages: The NASDAQ Composite
is heavily weighted in technology and Internet stocks. As such, the
companies listed in the composite are considered to have high growth
potential. Furthermore, 5000 companies in the index give it so/so diversification.
Note: This index is not to be confused with the NASDAQ 100.
The NASDAQ 100 Index
Launched in January 1985,
the Nasdaq-100 Index represents the largest non-financial domestic and
international issues listed on The Nasdaq Stock Market based on market
capitalization. The Index reflects companies across major industry groups
including computer hardware and software, telecommunications, retail/wholesale
trade and biotechnology. It does not contain financial companies including
The Wilshire Total Market
If you thought the S&P 500 and NASDAQ Composite Index included a lot of companies, here is an even larger one. The Wilshire 5000 Index, contrary to its name, contains over 7500 stocks that trade in the U.S. Investors often refer to the Wilshire as the "total market index" because it covers such a large and wide amount of shares - it is the largest index in the world.
Wilshire Associates in 1980
Advantages: Easily the most
diversified index in the world. It pretty much covers all of the public
companies in the United States.
The Russell 2000 Index
The previous four indexes we covered were all based on the top companies in the U.S., most of them billion dollar companies. The Russell 2000 measures the performance of smaller stocks that often get left out of the big indexes. The average market capitalization of each company in the Russell 2000 is approximately $530 million. To put that into perspective Microsoft alone has a market capitalization of over $300 billion (at time of writing).
Frank Russell Company in 1972
Advantages: A well diversified
index for smaller companies which have great growth potential.
What about Index Funds
These indexes are great tools for telling us what direction and trends the market is taking, how do we buy into these investment vehicles? Imagine the costs associated with buying the 7500+ stocks that make up the Wilshire or the 5000 stocks in the NASDAQ Composite. Commission fees alone would run in the tens of thousands of dollars.
Fortunately there is an easier way for individual investors to grab a piece of these indexes through an "index fund". Index funds are a portfolio of investments that are weighted the same as a stock-exchange index so as to mirror its performance.
The main advantage to an index fund is lower management fees than you would get from a regular mutual fund. The reason the costs are lower is because an index fund is not actively managed, instead fund managers only need to maintain the appropriate weightings to match the index performance. Also, the funny thing is, a majority (but not all) of mutual funds fail to outperform indexes like the S&P 500! In short, index funds offer diversity with low fees.
Some index funds can even
be bought as stocks through a traditional or discount broker. For example
the ticker symbol QQQ represents the NASDAQ 100, the 100 largest companies
trading on the NASDAQ.
So how's the market doing today? Depending on which index you look at you should be able to get a good indication of the overall health of the market, and over the long term you should be able to determine what shape the economy is in. Of the 6 different indexes we discussed many are similar, but not exact. Each one has a slight difference that tracks a different area of the market.
More importantly, investors
use these indexes as a benchmark against the performance of their portfolio
to see "how they performed compared to the market". If you
find yourself constantly under-performing these indexes then perhaps
its time to consider an index fund?