What is a stock index?
Grab your hot cocoa and find out.
In part 1 we talked about what mutual funds and exchange traded funds (ETFs) are. Now we’re going to talk about what stock indexes are. Are you feeling riveted or what?
Like I mentioned in Part 1, funds are baskets full of different slices of pie (stocks). Indexes are similar, but different. An index is also a basket full of different slices of pie, but it’s not an investment. You can’t buy or sell it. An index is a ruler— we use it to measure how the economy (or parts of the economy) are doing, and to see how our own investments measure up.
So what do we compare investments to? One of the most common benchmarks is the S&P 500 index. The S&P 500 index tracks the performance of the 500 largest US companies’ stocks. Even though it only represents 500 of the 3000+ stocks traded in the US markets, the S&P is used as a proxy for the whole US stock market, because those top 500 companies are so big that they determine the sway of the overall US markets.
When people talk about “beating the market”, they are saying, “Did my investment beat the performance of the S&P 500 index?”
Let’s have a closer look at this Benchmark Grandaddy. BTW S&P stands for Standard and Poors. Standard & Poors is a Wall Street company that analyzes the values of stocks and bonds, among other things.
The S&P index was created in 1957, and since then, its value has ballooned, despite several massive drops here and there. You may recall a few of these: the Dot Com Bubble, the Great Financial Crisis and a little something known as the Pandemic. Despite these plummets, on average, the S&P index returns 7% per year after adjusting for inflation.
So that’s a pretty good return.
The S&P is the most famous index, but there are many of them. Some other important ones are:
-The Russell 2000 index: this one tracks all the small US companies’ stocks (the ones that are left out of the S&P 500). And when I say small, I mean, the median value of one of these companies is $1.2 billion. So, you know, petite.
-The Nasdaq 100 —this is the 100 biggest tech stocks traded on the NASDAQ
-US Total Market Index—this is an index that includes every stock traded in the US stock markets
-Dow Jones Industrial Average: nobody really uses this one for anything useful, but it’s on the news every night, so I thought I’d mention it. It’s a collection of 30 stocks, usually of the largest US companies, but they get on the list by being picked by a committee, as opposed to just being humongous.
And there you have it, stock indices.