What you need to know about indexes
Today, there are an estimated 3 million indexes that provide benchmarks against which to measure investment performance and serve as recipes for the portfolios of a vast number of indexed mutual and exchange-traded funds.
Here’s a quick summary of some of the most common indexes.
Most weight their members based on market value, calculated by multiplying the stock price by the number of outstanding shares.
Large-company stocks. The S&P 500 index, launched in 1957, represents about 80% of the dollar value of the U.S. stock market. Though it tracks 500 firms, the index contains 503 stocks because a few members, such as Google owner Alphabet, issue more than one share class. The stocks are chosen by a secret committee convened by the owner of the index, S&P Dow Jones Indices. Committee members select generally large — but not necessarily the largest — U.S.-based firms they believe best represent the overall market while trying to keep changes to a minimum.
The Dow Jones industrial average, the granddaddy of market barometers, was created by Wall Street Journal founder Charles Dow in 1896. It is now also managed by S&P Dow Jones Indices, where a committee handpicks 30 “blue chip” large companies. The DJIA still follows Mr. Dow’s simple math and weights each member by stock price. Although originally designed to track the economically sensitive industrial sector, the Dow’s weighting in so-called cyclical stocks is roughly equivalent to that of the S&P 500.
Small-company stocks. The Russell 2000, the oft-quoted small-cap market barometer, is also the basis for about $91 billion in indexed fund investments, according to Morningstar. Provider FTSE Russell starts with an analysis of approximately 4,000 U.S. public companies. The 2000 consists of stocks, ranked by market value, that fall between 1,001st and 3,000th place.
S&P SmallCap 600 is a more selective list of small companies. S&P will only add companies that have been profitable for the past year, for example. The selection committee tries to ensure that the index represents all sectors of the economy.
International stocks. FTSE Global All Cap ex U.S. tracks 98% of the investable market outside the U.S., including developed and emerging markets and companies of all sizes. Japanese companies are the biggest contributors, making up about 15% of the index, followed by firms in the United Kingdom, China and Canada.
MSCI EAFE is the oldest international index, tracking large and midsize company stocks in 21 developed countries in Europe and the Far East, as well as Australia and New Zealand. It excludes the U.S. and Canada. Companies from Japan, the United Kingdom and France make up about half the index.
Bonds. Bloomberg U.S. Aggregate Bond, familiarly known as the “Agg,” tracks U.S. taxable, investment-grade bonds (those rated BBB and above), including Treasuries, corporate IOUs and asset-backed securities. It excludes junk bonds and those with variable rates, as well as issues of less than $300 million or with maturities of less than a year.