Stock Indices Explained
I know investing is scary for a lot of people.
So, today, I’d like to mention a few quick notes about some of the more commonly referenced stock indices. While this is in no way a complete guide, I hope that it helps you at least understand some of the language frequently used when discussing indices.
Index funds are an increasingly popular way to invest.
But, I’d like to note that not all index funds are created equal. As always, I encourage you to do more research before making any financial decisions.
I’d also like to note that just because the data is available for what annualized returns an index fund has been yielding, that it is not a guarantee that the trend will continue. Just because index fund 1 has been yielding an annualized return of 9.08%, and index fund 2 has been yielding 7.50%, does not necessarily mean you should automatically go with index fund 1. (You should make an index fund investment decision based on more factors than what the annualized returns have been in the past anyways.)
Before we start with the indices though, I want to explain what indices usually seek to measure, which are stock exchanges.
(Also, if you’re a total stock market beginner, check out my article on stocks and basic investing here first!)
U.S. Stock Exchanges
A stock exchange is a market where types of securities are bought and sold. There are many stock exchanges to choose from today, but the biggest ones are:
- New York Stock Exchange (NYSE) (nyse.com): world’s largest stock exchange in terms of the market capitalization of its listed stock; located in New York, NY; many NYSE trades have now transitioned to electronic trades, but floor traders are still used here today as well
- National Association of Securities Dealers Automated Quotations (Nasdaq) (nasdaq.com): the second largest exchange in the world based on market capitalization; was the world’s first electronic stock market; specializes in electronic trading, no physical location unlike the NYSE; focuses mostly on technology and corporate deals
Stock indices (or indexes) are statistical aggregates that seek to measure a stock market’s performance over time. There are many, many different indices (just like stock exchanges), so I am only going to discuss some of the more commonly referenced ones today (You can check out some more of the top stock indices here).
Hopefully, by reading about these, you can “get the gist” of how indices typically work and the terms they like to use.
- Standard and Poor’s 500 (S&P 500) Index: comprised of 500 of the most widely traded stocks in the U.S.; represents about 80% of the total value of the US stock markets; is a market-capitalization-weighted index fund (stocks are represented proportionally here to their total market capitalization); good indicator of the U.S. large-cap market in general
- Top sectors include (as of August 31, 2017):
- Information technology (22.5%)
- Financials (14.7%)
- Healthcare (14.1%)
- Consumer discretionary (12.4%)
- Industrial (10.7%)
- Top sectors include (as of August 31, 2017):
- Nasdaq Composite Index: market-capitalization-weighted index of all stocks traded on the Nasdaq; large proportion is technology stock, just like the exchange it seeks to follow
- Nasdaq 100 Index: not to be confused with the Nasdaq Composite, they are two different indices; comprised of the 100 largest non-financial companies on the Nasdaq stock market
- Dow Jones Industrial Average (DJIA) Index: one of the oldest, most well-known, most frequently used indices in the world; includes stock of the 30 largest and most influential companies in the US; represents about a quarter of the total US stock market value; price weighted index (stocks with higher prices are weighted higher and have more of an impact on the movement of an index than stocks with low prices do)
- NYSE Composite Index: comprised of all the common stock listed on the NYSE
- Russell 3000 Index: comprised of the 3,000 largest publicly traded companies in the U.S. stock markets
- Russell 2000 Index: market-capitalization-weighted index of the 2,000 smallest stocks in the Russell 3000; best known indicator of daily performance of small companies
- Wilshire 5000 Index: “total stock market index”, almost all publicly traded companies headquartered in the US comprise Wilshire 5000
- Chicago Board Options Exchange’s (CBOE) Volatility Index (VIX): measure of the implied volatility of the S&P 500 index options over the next 30 days; VIX replaces the older VXO
So, there you go! Of course, there are loads of more indices, but at least now you know some of the basics! Happy investing!