If you’ve been in the investing world for a minute, you’ve likely heard the word “index” thrown around quite a few times. But what the heck actually is an index? And why should you care?
Well, indexes are actually pretty darn cool.
In this article, I’ll break down (in simple terms) what an index is, how financial indexes (or indices – both are correct) work, different types of indexes, and more. I’ll also cover a bit on how to invest in indexes and why you might want to.
First things first:
What is an Index?
An index is a way to measure or track something using numbers.
In the case of financial markets, indexes are typically used to track the performance of a group of assets such as stocks, bonds, currencies, real estate and other securities. The value of an index — sort of like a score — gives investors a quick snapshot at how the underlying assets in that index are performing.
Example: The S&P 500 is a popular index that represents the performance of 500 of the largest public companies in the U.S.
Indexes are useful because you can use them to track market trends in different sectors, industries, investment styles, and more. You can also use them as a benchmark for your investment returns, or as a guide for building a diverse portfolio.
Market Index Weighting Methods
Weighting determines the overall impact each individual security will have on an indexes value.
Example: The S&P 500 is a market-cap weighted index. That means companies with a larger market capitalization (calculated by multiplying total outstanding shares by share price) have a bigger impact on the indexes price.
Popular weighting methods include:
- Market-cap weighted: Securities are weighted based on their market capitalization (i.e. held shares x share price).
- Price-weighted: Securities are weighted based on their market price (i.e. actively traded stock price).
- Equal-weighted: Securities are all given an equal weight regardless of price or market cap.
Keep in mind, indexes can be weighted by other factors too, including revenue, earnings, sentiment, volatility, and more.
Major Market Indexes: Types and Examples
Major Stock Indexes
Stock indexes track the performance of equities in a range of sectors, industries, and markets.
Examples of some major stock indexes include:
- MSCI All Country World Index: Market-cap weighted. Tracks companies in both developed and emerging markets around the world, covering approximately 85% of investable equities worldwide.
- S&P Global 1200: Market-cap weighted. Tracks 1,200 of the largest publicly traded companies in the world, spanning 31 countries and 11 sectors. Covers approximately 70% of the global stock market capitalization.
- S&P 500: Market-cap weighted. Tracks 500 of the largest companies in the U.S.
- NASDAQ Composite: Market-cap weighted. Tracks the top 3,000 companies on the NASDAQ Stock Exchange. Known for being heavy in tech and growth stocks.
- Dow Jones Industrial Average: Price-weighted. Tracks 30 large-cap companies in the U.S. that are considered to be leaders in their industries.
- FTSE 100: Market-cap weighted. Tracks 100 of the largest companies on the London Stock Exchange.
- Nikkei 225: Price-weighted. Tracks 225 of the largest companies on the Tokyo Stock Exchange.
- Russell 2000: Market-cap weighted. Tracks 2,000 small-cap companies in the U.S.
- NIFTY 50: Market-cap weighted. Tracks the top 50 companies on the National Stock Exchange of India.
- S&P/ASX 200: Market-cap weighted. Tracks 200 of the largest companies on the Australian Securities Exchange.
- S&P/TSX Composite: Market-cap weighted. Tracks 250 companies — making up ~70% of the total market cap — on the Toronto Stock Exchange in Canada.
- DAX 30: Market-cap weighted. Tracks 30 of the largest companies on the Frankfurt Stock Exchange in Germany.
- CAC 40: Market-cap weighted. Tracks 40 of the largest companies on the Euronext Paris Exchange.
- Hang Seng: Market-cap weighted. Tracks 50 of the largest companies on the Hong Kong Stock Exchange.
- CSI 300: Market-cap weighted. Tracks the top 300 companies on the Shanghai and Shenzhen exchanges in China.
Major Bond Indexes
Bond indexes track fixed-income securities like government bonds, corporate bonds, high-yield bonds, and more.
Examples of major bond indexes include:
- Bloomberg Barclays U.S. Aggregate Bond Index: Market-cap weighted. Tracks investment-grade (high-grade) bonds in the U.S.
- Bloomberg Barclays Global Aggregate Bond Index: Market-cap weighted. Tracks investment-grade bonds around the world.
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Major Real Estate Indexes
Real estate indexes track things like real estate investment trusts (REITs), real estate companies, home builders, and more.
Examples of major real estate indexes include:
- FTSE EPRA/NAREIT Global Real Estate Index: Market-cap weighted. Tracks publicly traded real estate companies from around the world.
- S&P Global Property Index: Market-cap weighted. Also tracks publicly traded real estate companies from around the world.
- FTSE NAREIT All Equity REITs Index: Market-cap weighted. Tracks all publicly traded real estate investment trusts (REITs) on major U.S. stock exchanges.
- Dow Jones U.S. Real Estate Index: Market-cap weighted. Tracks publicly traded real estate companies in the U.S. including REITs, real estate operating companies, and home builders.
Major Commodity Indexes
Commodity indexes track the performance of raw materials like gold, crude oil, wheat, coffee, cotton, sugar, corn, cattle, and more.
Examples of major commodity indexes include:
- S&P GSCI: World production weighted (higher production = greater impact on the index). Tracks a group of 24 commodities worldwide including energy, agriculture, metals, and livestock.
- Bloomberg Commodity Index: Market-cap weighted. Tracks 23 commodities worldwide including energy, metals, agriculture, and livestock.
Major Cryptocurrency Indexes
Cryptocurrency indexes track the performance of multiple cryptocurrencies.
Exampels of major crypto indexes include:
- Nasdaq Crypto Index: Market-cap weighted. Tracks large USD-traded cryptocurrencies listed on at least two vetted exchanges and supported by at least one vetted custodian. Includes cryptos like Bitcoin, Ethereum, Litecoin, Chainlink, Polkadot, Bitcoin Cash, and more.
- Bitwise 10 Crypto Index: Market-cap weighted. Tracks the top 10 cryptocurrencies.
Major Currency Indexes
Currency indexes measure the value of one currency relative to a basket of other currencies.
Examples of major currency indexes include:
- U.S. Dollar Index (DXY): Tracks the U.S. dollar relative to foreign currencies like the euro, yen, pound, Canadian dollar, and others. Weighting is determined by the U.S. Federal Reserve and is based on trade flows.
- Euro Currency Index (EURX): Similar to the above, but measures the performance of the euro.
There are similar indexes for most major currencies.
Other Types of Market Indexes
There are many other types of market indexes/ways to categorize indexes besides the popular ones listed above.
Here are some examples:
- Broad Market Indexes: Track the performance of a large portion of the market. Example: S&P 500.
- Sector Indexes: Track specific sectors of the market, like tech, healthcare, energy, utilities, consumer goods, and financials. Example: Technology Select Sector Index, which tracks tech stocks on the S&P 500.
- Industry Indexes: Track a specific industry, like oil, which is a part of the energy sector.
- Style Indexes: Track different investment styles, like value or growth.
- Global Indexes: Track securities in multiple regions across the globe.
- Regional Indexes: Track securities in a specific region or country.
- Environmental, Social, and Governance (ESG) Indexes: Track socially conscious and sustainable companies based on ESG scores, which are calculated using factors like climate impact, labor practices, and diversity
- Alternative Investment Indexes: Track alternative investments like art.
- Volatility Indexes: Track the volatility of specific assets or markets. Example: CBOE Volatility Index (VIX), which tracks the expected volatility of the S&P 500.
- Strategy Indexes: Track specific investment strategies like high-dividend yields or value.
How to Invest In Indexes
“A low-cost index fund is the most sensible equity investment for the great majority of investors.”
– Warren Buffett, The Little Book of Common Sense Investing, 2007
Investing in indexes is a great, low-cost way to quickly and easily diversify your portfolio. However, indexes themselves can't be invested in directly — that's where index funds come into play.
An index fund is a type of mutual fund or exchange-traded fund (ETF) that aims to track and replicate specific indexes for investing purposes.
There are slight differences between the two:
- Exchange-traded index funds are traded directly on stock exchanges, just like individual stocks. Their price varies throughout the day, and you can buy or sell them freely whenever the markets are open. Due to being passively managed (algorithms do all the work), they typically have very low fees. Examples include:
- SPDR S&P 500 ETF (SPY): Tracks the S&P 500 index.
- iShares Core U.S. Aggregate Bond ETF (AGG): Tracks the Bloomberg Barclays U.S. Aggregate Bond Index.
- iShares MSCI ACWI ETF: Tracks the MSCI All Country World Index.
- Mutual index funds are priced once per day and can only be bought and sold at the end of the trading day. They're managed by professional investors, which is why they typically have higher fees than ETFs, but also more options for customization. Examples include:
- Vanguard 500 Index Fund (VFIAX): Tracks the S&P 500.
- Vanguard Total Bond Market Index Fund (VBTLX): Tracks the Bloomberg Barclays U.S. Aggregate Float Adjusted Index.
Overall, what you end up picking will depend on your needs. When comparing mutual funds and ETFs, be sure to consider things like expense ratios (fees), trading costs, and minimum investments to figure out what fits best with your investment goals and strategy.
Where to Start Investing
There are plenty of investing platforms out there that enable you to invest in index funds. A few options include Wealthsimple, Robinhood, and Acorns.
Check out our platform discovery tool for more options.
Final Thoughts
Ok, hopefully you now have a better idea of what market indexes are, how they work, and why they're useful.
In the end:
Indexes are great for getting an overview the markets and for creating diverse and personalized investment portfolios at a low cost.
If you have any questions or comments, drop 'em below.
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