Historically, stock market indexes have
been closely watched as an indicator of the market's overall performance.
While that role is still important, the number of stock market
indexes has grown explosively as mutual funds and investment managers
search for relevant indexes to use as benchmarks to compare performance.
Indexes are also increasingly used as the base for investment
products, allowing investors to invest in defined segments of
the market without purchasing all of the underlying stocks in
the index.
Indexes can be computed in different ways.
Some, like the Dow Jones Industrial Average (DJIA), are calculated
using an arithmetic average. The prices of stocks are added and
then divided by the number of securities in the index, although
the divisor is adjusted over time for splitting of shares, distribution
of stock dividends, and to account for company substitutions in
the index. These indexes do not adjust for the company's total
market value, so stocks with the highest share prices have more
impact on the index. Other indexes, such as the Standard &
Poor's 500 (S&P 500), use market-value weighting, factoring
in the differences in individual stocks' market value by multiplying
the price of each by the number of shares outstanding. Thus, major
corporations have a greater influence on the index than small
companies.
Another important calculation difference
is whether the index is a capital return or total return index.
A capital return index, such as the DJIA and the S&P 500,
only reflects changes in the shares of the stocks in the index.
Total return indexes, such as the Russell 2000 and the Wilshire
5000, calculate both share price changes and dividend reinvestment.
Some of the major stock market indexes include:
The Dow
Jones Industrial Average
is comprised of 30 large-company stocks.
All of the companies are billion-dollar giants, with no small-
or medium-sized firms in the index. Despite the small number of
companies in the index, the index is the oldest and most widely
quoted measure of the U.S. stock market.
The Standard
& Poor's 500
is comprised of 500 large-company stocks
trading on the New York Stock Exchange, the American Stock Exchange,
and Nasdaq, covering a wide variety of industries. This index
is considered more representative of the U.S. stock market than
the DJIA. Additionally, various component indexes are calculated
from this index, including the 400 industrials, 40 utilities,
20 transportation companies, and 40 financial stocks.
The Nasdaq
Composite Index follows the approximately
5,000 stocks that trade on Nasdaq. This index is generally viewed
as a good benchmark for technology stocks.
The Russell
2000 Index is viewed as a good benchmark
for the performance of smaller-company stocks. The stocks in the
index include the 2,000 lowest-capitalization stocks from the
Russell 3,000, which includes the 3,000 largest-capitalization
stocks in the U.S. stock market.
The Wilshire
5000 Index, despite its name, consists
of over 6,000 stocks, including almost all stocks traded on major
exchanges and gives the broadest view of the U.S. stock market.
If you want to compare your investments'
performance to an index, select one that tracks the same types
of stocks you hold in your portfolio. Keep in mind, however, that
indexes do not incur any trading costs or taxes.
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