The media report daily on the results of investment indexes. When you hear that the S&P 500 is up, do you know if that means your investments are doing well? Let’s review a few types of indices and what they represent.
A stock index or stock market is a measurement of the value of a section of the stock market. The market itself is a loose network of economic transactions, not a physical facility. A stock market, equity market or share market is the aggregation of buyers and sellers of stocks, which represent ownership claims on businesses. Stock exchanges list shares of common equity as well as other security types like corporate or convertible bonds.
The S & P 500 Index stands for the Standard and Poor’s 500. It is an American stock market index based on the measurement of the value of 500 large companies having common stock listed on the New York Stock Exchange (NYSE) or Nasdaq Stock Market (NASDAQ). The S & P 500 is a market value-weighted index. This means that the larger components carry higher percentage weightings, while the smaller components in the index have lower weights. This type of index is also called a capitalization-weighted index. Larger companies in the index will have a more dramatic effect on the value of the index. This index is one of the most commonly followed equity indices, and many consider it one of the best representations of the U.S. stock market and a lead indicator for the U.S. economy. Some of the top companies in the S & P 500 are Amazon, Johnson & Johnson and Exxon Mobil Corp.
In contrast to the market value-weighted S & P 500, the Dow Jones Industrial Average (DJIA) is a price-weighted average of 30 significant stocks traded on the NYSE and the NASDAQ. The DJIA is often referred to as “the Dow” and is one of the oldest, single most-watched indices in the world. The price-weighted index means each stock influences the index in proportion to its price per share. The value of the index is generated by adding the prices of each of the stocks in the index and dividing them by the total number of stocks. Stocks with a higher price will be given more weight and, therefore, will have a greater influence over the performance of the index. Companies such as General Electric, Walt Disney, Exxon Mobil and Microsoft are among the holdings. Often when you hear a TV network report “the market is up today”, they are generally referring to the Dow. This can be misleading because this index only measures 30 companies as opposed to the S & P, which is measuring 500 companies that represent 70% of the total stocks traded in the United States.
Other prominent indices include the DJ Wilshire 5000 and the MSCI EAFE (Europe, Australia and Far East). The Wilshire 5000 is now called the DJ Wilshire 5000, renamed in April of 2004, after Dow Jones & Company assumed responsibility for its calculation and maintenance. This is a total market index of all stocks actively traded in the U.S. The MSCI EAFE is a stock market index designed to measure the market performance of developed markets outside of the U.S. and Canada. It is maintained by Morgan Stanley Capital International (MSCI).
The different indexes can be used as benchmarks for measuring the performance of a security, mutual fund or investment manager. Using an index that most closely resembles your investment is important if you really want to compare “apples to apples”.
September 21, 2017