What is an Index?

 

An Index is a statistical way of valuing and tracking a specific section of the economy.

Indices exist for tracking nearly every aspect of the economy. There are stock indices which track the stock market, bond indices that track the bond market, indices that track rates charged by shipping companies, etc.

 

Perhaps the most well known stock index is the S&P 500 Index. This index is made up of 500 large American companies stock. This index is used by many economists to track the performance of the general stock market. However it is just one of many stock indices that exist.

 

The S&P 500 index increases or decreases based on the collective movements of the stocks which make up the index. Even if the index is up, some stocks that make up the index may be down or vice-versa.

The movement of the S&P 500 index is charted below. Changes in the value of the index reflect changes in the prices of the collection of companies that make up the index.

 

 

 

The calculations to produce and upkeep an index are fairly complicated and outside the scope of this article and this website in general. Beginning  investors just need to know that an Index tracks a segment of the economy.

 

As an investor, you can not invest directly in an index; however there are Index Funds which are made to track a specific index.

 

In our “Fund Spotlight Series” we detailed several of the most popular S&P 500 Index Funds here.

 

An S&P 500 index fund will buy and hold stocks that exactly match the makeup of the S&P 500 index. Index funds are a type of “passive management” investment, where fund managers are only trying to match an index.

This differs in comparison to active traders and fund managers who will invest their money in only specific securities within an index, trying to pick out the winners and losers to gain more than the general index.

 

Indices are used as a benchmark for investors and asset managers to compare their returns with. It is very easy and inexpensive to invest in an index fund, so the returns of the general index are often compared with investor’s returns to see if they were able to “beat the market”.  Historically, professionals and individuals alike have had a hard time consistently beating their index.

 

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