As promised in a previous article, I wanted to take the time to explain the various stock market indexes, how they differ, how they can help interpret economic performance, and how they can assist investors in deploying capital as investors consider various economic interpretations.
Before defining the stock market indexes, there are important advantages and disadvantages of each index. One of the biggest potential issues and concerns is the weighting of various positions within the index – how large or small a representation any single company represents within the index. For example, the S&P 500, which represents the performance of 500 companies, is not necessarily diversified. The index is market-cap weighted, so larger companies make up a larger proportion of the index. The top 7 companies represented makeup over 25% of the index. Apple itself makes up over 7.5% of the S&P 500. Such a large position can disproportionately impact the overall index performance.
There are several advantages to investing in index funds, one of which is the many types of index funds – meaning Exchange Traded Funds (ETFs) or “Mutual Funds” that invest in a specific, or even a basket of index funds. Index funds are also typically a low-cost option as they are passively managed, meaning you won’t pay a large fee like you would with a traditional mutual fund.
The key is understanding what you own, what the company or index does, and why you own that specific investment.
Here are several examples of stock market indexes that are used to gauge stock market – or even bond market – performance.
They also are provided as investment options through various companies:
1. S&P 500 Index: The S&P 500 is a widely followed index of 500 large-cap U.S. companies. It is one of the most actively traded index options, used as a benchmark to determine the performance of a portfolio, and is often utilized by investors for hedging and speculation.
The S&P is market-cap weighted, so larger companies represent a larger portion of the index.
2. NASDAQ-100 Index: The NASDAQ-100 includes 100 of the largest non-financial companies listed on the NASDAQ stock exchange. It has historically represented more technology companies than other indexes, however, most index options are heavily weighted in technology due to the size of the technology sector. This is a popular option used by many investors.
3. Dow Jones Industrial Average (DJIA): The DJIA consists of 30 major U.S. companies across various industries. Though not as widely traded as S&P 500 options, DJIA options are still popular.
It is important to note that the DJIA is “price-weighted”, so if a company has a higher stock price, it will represent a larger portion of your investment. A $300 stock will make up more of the investment than a $25 stock, regardless of the market cap (or size) of the company.
4. Russell 2000 Index: The Russell 2000 tracks 2000 small-cap U.S. companies. Options on this index provide exposure to smaller companies and can be used for diversification.
5. VIX (CBOE Volatility Index): The VIX measures market volatility and is often referred to as the "fear index." Its options allow investors to speculate on or hedge against market volatility. Many of these investment options are leveraged, meaning they will provide a larger movement in the price of the investment, however, they include significantly more risk due to the leverage.
6. FTSE 100 Index: The FTSE 100 represents the 100 largest companies listed on the London Stock Exchange. It's a popular index option for investors interested in the UK market.
7. DAX Index: The DAX tracks the 30 largest companies on the Frankfurt Stock Exchange in Germany. It's a key index option for European market exposure.
8. Nikkei 225 Index: The Nikkei 225 is a major stock market index for the Tokyo Stock Exchange in Japan. Options on this index offer exposure to the Japanese market.
While there are many more indexes we can discuss, I would recommend speaking with a financial advisor, determining your risk tolerance, and ensuring the investments you own are appropriate for your financial plan.
We at PHP Capital are committed to educating our clients and community. If you have any questions, contact us using the form at the bottom of the page or call us at (720) 284-2372.
"Indices are unable to be invested in directly. Funds may attempt to track indices by mirroring their makeup, but are subject to tracking errors where there is a difference in performance between the fund and the associated index."