What's in an Index?
There are a number of indexes that attempt to measure the performance of the financial markets and serve as a gauge of economic activity. The following are descriptions of several of the most common indexes:
Dow Jones Industrial Average
The Dow is the most widely recognized and quoted index. Consisting of only 30 US domiciled stocks, it is generally the narrowest measure of market performance. Oddly enough, the stocks with the highest price are given the largest weighting in the index (a stock split would reduce a company’s weighting in the index). Dividends paid by Dow companies are generally not considered when calculating the performance of this index.
S& P 500
The S&P 500 is the most commonly referenced U.S. equity index and is comprised of the 500 largest U.S. companies. The S&P 500 is market capitalization weighted, meaning the largest companies constitute the largest weightings in the index. For example, at present, the top 10 stocks in the index constitute a 20% weighting and the remaining 490 companies constitute an 80% weighting.
The Russell 2000 index is a generally accepted benchmark for the performance of small companies. The Russell 2000 Index is more evenly weighted than most, as the top 10 holdings represent less than 2% of the index's overall value.
The Wilshire 5000 is considered the “total market index.” It is by most accounts, the best reflection of overall stock market performance. The index is market cap weighted, meaning that the firms with the highest market value account for a larger portion of the index. Dividends are generally excluded when calculating the performance of this index.
The purpose of the Nasdaq Composite index is to gauge the performance of the “highest growth” companies that are primarily in the technology sectors. Containing roughly 4,000 companies, the Nasdaq Composite contains both domestic and international stocks. The top 5 companies in the Nasdaq constitute nearly a 20% weighting. The Nasdaq reached its peak of just over 5,000 in March 2000 – it is now priced at around 3,050.
MSCI EAFE (Europe, Australasia, and Far East)
Developed and maintained by Morgan Stanley, the EAFE is an index that tracks the performance of stocks from 21 developed countries (excluding the U.S. and Canada). Companies located in the U.K., Japan and France currently represents in excess of 50% of the MSCI EAFE index.
Barclays Aggregate Bond Index
The Barclays Aggregate Index is comprised of a basket of both corporate and government bonds of varying maturities and credit qualities. The performance of this index is based on both interest payments and price appreciation (or depreciation) of the bonds held in the index.
For those investors who maintain a globally diversified investment approach, it is important to understand the intricacies of the more popular indexes when benchmarking the performance of your portfolio.