A lot of people who are new to investing may not be too sure what an index actually represents. When you hear the media talk about the behavior of the stock market in terms of points that go up and down on a daily basis, well they’re talking about how an index behaves right there — whether it be the Dow Jones Industrial Average, the S & P 500, the Nasdaq or something else.
So What’s A Stock Market Index?
What a stock market index is, is simply a measure of the discrepancies in a stock portfolio that represents a piece of the stock market. Since it’s pretty much impossible to keep track of every thing that’s traded in the markets, this measure was invented to represent a smaller sampling that would ultimately reflect the bigger picture. Sounds simple enough? We can measure the health of the markets by simply checking on how its representative indexes are doing. The bottom line here is that index price changes reflect the exact proportional changes in the prices of stocks that are part of the index.
I found it interesting that indexes can be whipped up by just about anyone (or any financial body). For example, during crazy bull markets of yore, everyone and their brother would formulate new indexes that were “marketed” and introduced to investors. Remember those internet dot com stock indexes or new economy stocks that were pretty hot at one point? While new indexes can come and go, I’d only pay attention to those indexes that have managed to stick around and which have been developed by reputable, upstanding financial companies such as Dow Jones & Company, the folks who publish the Wall Street Journal. They’re the ones responsible for the DJIA, the granddaddy of all indexes.
Index Funds, ETFs and the Indexes They Track
If you’re like me, then you must love index funds and index ETFs. Index funds and ETFs track their benchmark indexes. For some examples, here are a few that I like and the indexes they represent:
- The DIA (Dow Diamonds) ETF tracks the Dow Jones Industrial Index.
- E*Trade S & P 500 Index Fund (ETSPX) tracks the Standard & Poor’s 500 Index.
- Fidelity Nasdaq Composite Index Fund (FNCMX) tracks the Nasdaq Composite Index.
- Russell 2000 Index Fund (IWM) tracks the Russell 2000 Index (small cap stocks).
- Vanguard Total Stock Market Index Fund (VTSMX) tracks the Wilshire 5000 Total Market Index. The Wilshire 5000 is supposed to represent the entire U.S. stock market.
- The MSCI EAFE Index Fund (EFA) tracks the MSCI EAFE Index.
- Vanguard Total Bond Market Index (VBMFX) tracks the Barclays US Aggregate Bond Index.
Here’s the thing: there are a lot of index funds and possibly ETFs that are available from various financial institutions which do the job of following these indexes. Vanguard, the largest and most well-known mutual fund company (and low cost fund house due to their emphasis on indexing) certainly has many index fund choices you may want to review if you’re interested in getting into indexing. These financial vehicles are some of the lowest cost (if not the lowest cost) investments you can possibly get into, as a small investor. They’re definitely a part of my core portfolio and have served me extremely well throughout the years!