Stock Market Indexes
We already learned about some of the stock markets around the world. An ‘index’ is something that measures the change in such a market. An ‘index fund’ invests broadly in order to match the performance of that index.
Are you with me? No? Okay, here’s an example:
One of the most well-known indexes in the world is Standard and Poor’s 500 (S&P 500). It follows the 500 largest, publicly-listed companies in the United States, which covers about 75% of the trade there. The S&P 500 rises and falls with the market, showing what is happening overall. Some stocks will rise while others fall, but the index can give us an overview. It does this by assigning the market an arbitrary number, and then records in point form whether it has risen or fallen.
The S&P 500 takes into consideration how large each stock is, or its ‘market capitalization’. That means movements in the value of big companies will make more of a difference than the movements of small companies. It is a ‘weighted’ index.
An index fund uses such an index as a benchmark. That is, it attempts to match the performance of that market overall. More about this soon. First, here are some of the other main indexes:
Dow Jones Industrial Average (DJIA)
This is one of the oldest indexes. It tracks thirty, mostly blue-chip stocks listed on the New York Stock Exchange and the NASDAQ. It is not weighted in the same way as the others and it’s very narrow, but it’s such a classic that the financial media still follow it, perhaps for old time’s sake. The pros tend to pay more attention to the larger and more logically weighted S&P 500.
NASDAQ Composite Index
You might remember that there’s a US stock market called the NASDAQ. Well, this is an index that tracks 3,300 equities traded on the market. The companies listed do not need to have their headquarters in the US to be included.
This index is tech-heavy so the performance of the FAANG stocks (Facebook, Apple, Amazon, Netflix and Google) make a big difference to its overall performance. They constitute around 27% of the total index.[i]
Like the above, but guess how many equities this one tracks? Anyone? Yup, it’s a hundred of the largest, most actively traded stocks.
Tracks the top 225 blue-chip stocks in Japan. Often just called the Nikkei.
Hang Seng Index (HSI)
We’re not being mean to a guy called Seng here. This is the name of an index that tracks the largest companies on the Hong Kong Exchange.
Financial Times Stock Exchange Group (FTSE 100)
This is the weird one you’ve heard in the financial news when they mention the ‘Footsie’ and you think it’s something about fooling around under the table. It tracks 100 blue-chip companies on the London Stock Exchange.
There are many other indexes like the ASX 300 which follows the 300 largest companies on the Australian Securities Exchange, the S&P TSX, which tracks the Toronto Stock Exchange and the S&P NZX which tracks the 50 largest New Zealand stocks.
An index is a measure of change in a stock market. It shows whether the market is going up or down and by how much. It is these indexes that give us the graphs and points we see on TV.
Now when you hear the financial news, it will sound a lot less like gobbledygook and you can impress friends and lovers with your vast knowledge.
Having said that, you don’t need to follow such news. If you’re investing in shares for the long term, daily movements make no difference. You do need to understand indexes in order to understand how an index fund works, however, and that’s coming up next.
[Edit: I just realised that this is scheduled to go up on Christmas Eve. Who’s reading this?
Whoever you are, have a Merry Christmas and a Happy New Year. Now stop neglecting your family and being sober.]
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