Understanding the Indexes

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Anyone wanting a steady, secure retirement should know it is paramount to start investing for one’s golden years as soon as possible. Also, there is no set amount regarding how much someone should have in the bank for relaxing from their mid-60s onwards, as that can substantially vary, depending on multiple factors, including the desired lifestyle, an individual’s health, location, and other personal circumstance.

Nevertheless, one guideline that many like to implement is the 4% rule. It recommends that retirees have enough saved up that they can take out 4% of their portfolio per year in retirement. So, for a yearly retirement income of $40,000, one usually must have a portfolio that boasts a cool million dollars. Another way to approach living through non-working later-life years is to create an investment pool that totals 25x a person’s annual expenses for this section of their life. That would mean that, after retirement, that individual has enough cash to live off comfortably for the next two and a half decades.

For all investors to ensure they are on the right track to hitting these and other goals. They must understand the process of measuring investment performance. One of the most popular ways of doing this is through utilizing indexes. What are those? Well, they are statistical measurements tracking the well-being of a specific set of securities, acting as a benchmark against which an investor can assess how their investments are doing. As a rule of thumb, indexes get created using a weighted average of the individual securities based on each security’s market capitalization. Hence, more massive entities have a more significant influence on the performance of an index than smaller ones.

Below, we look into the most renowned indexes in the global investment sphere, explaining each briefly. Before diving into that, we should note that traders can also put their money in index funds or exchange-traded ones that track these indexes. That lets them attain exposure to a diversified portfolio while incurring relatively low expenses and fees.

S&P 500

The S&P 500, or the Standard and Poor’s 500, is, according to most, the best indicator of the overall health of the US economy and the country’s stock market. It is likely the most commonly followed index, as it features the leading five hundred publicly traded companies in the US, with a chief emphasis on market capitalization. It was launched by the credit rating agency Standard and Poor’s, hence its name, in 1957. It gets classified as a float-weighted index, and due to its diversity and depth, it gets wildly used as a benchmark to gauge the relative performance of investment portfolios.

The S&P Dow Jones Indices, a joint venture between the CME Group, S&P Global, and News Corps, maintains the S&P 500. It gets continuously updated to accurately reflect market changes and removes/adds companies via multiple criteria like sector representation, liquidity, and market cap. It is a super-adequate yardstick for anyone to measure the success of their group of trades to the broader market.

Dow Jones Industrial Average

Also known as the Dow, the DJIA, or the Dow Jones Industrial Average is an index of the stock market kind that tracks the health of the thirty most sizable publicly-traded entities on the NASDAQ and the NYSE (New York Stock Exchange). It gets calculated by totaling the prices of its entities and dividing them by a divisor that adjusts for corporate actions like dividends and stock splits.

The DJIA was created by Edward Jones and Charles Down in 1896, and it now incorporates companies from multiple industries like healthcare, finance, and technology. It is maintained by S&P Dow Jones Indices, the same as the S&P 500.

NASDAQ Composite

The National Association of Securities Dealers Automated Quotations index, more famous under the acronym the NASDAQ Composite, is a stock market index that monitors the state of all the entities appearing on the NASDAQ exchange. Created in 1971, one of the top claims to fame of the NASDAQ exchange is that it was the world’s first electronic one, with its index coming to life a year after its creation. It is maintained by a subsidiary of Nasdaq Inc named NASDAQ OMX and works super similar to the S&P 500.

Things that make this index unique are that it has a heavy focus on technology stocks, and as a byproduct of this, it tends to experience sharp fluctuations, be more volatile compared to other indexes, and many of the companies it lists have high growth potential, and are relatively new.

Russell 2000

Here is a small-cap stock market index, a subset of the broader Russell 3000 index. It was started in 1984 by the Frank Russell Company and maintained by a subsidiary of the LSEG (London Stock Exchange Group), FTSE Russell. The initial idea behind its creation was to supply investors with exposure to the US stock market’s small-cap segment. It tracks two thousand small-cap US companies. That refers to ones with a market capitalization between $300 million and $2 billion and is vital because these often have more expansion potential than larger ones. Thanks to that, it indirectly generates deeper insights into the growth opportunities of the US economy and its trends.

The Russell 2000 is an equal-weighted index. Therefore, each entity in it has an equal impact on its performance, unlike in the S&P 500, where bigger players have a much more impactful role. Also, the Russell 2000 index offers total transparency, clearly listing its objective criteria, which helps investors grasp how the index gets constructed and how it may perform over time.

FTSE 100

The FTSE 100 index, in investment circles, also goes by the moniker – the Footsie, the acronym FTSE, and in media publications, it sometimes gets listed under its full name – The Financial Times Stock Exchange 100 Index. It is a share stock index tracking the one hundred most sizable companies, by market cap, on the London Stock Exchange. Like the Dow and the S&P 500, it is a capitalization-weighted index, and it was created in the same year as the Russell 2000, 1984. The organization responsible for its birth was the FTSE (Financial Times Stock Exchange), a joint venture between The Financial Times newspaper and the London Stock Exchange. Today, the FTSE Russell subsidiary of the LSE maintains this index, which is the prime barometer of the state of affairs of the UK economy.

The FTSE 1000 is the index to implement for anyone whose portfolio concentrates on UK securities, as it monitors Britain’s most influential business entities, mostly weighing toward the resource and financial sectors. Furthermore, another distinct aspect of this index is that many entities that comprise it have significant operations outside of the UK, meaning it has international exposure.

Nikkei 225

Regarding the Asian securities trading arena, the Nikkei 225 is a price-weighted index of paramount importance. It tracks the performance of two hundred and twenty-five publicly traded Japanese companies from varied industries. It operates under the Yen, and its components get reviewed annually. Its main competitor is TOPIX, or the Tokyo Stock Price Index, which oversees the activity of all domestic companies of the Tokyo Stock Exchange’s Prime market division.

Japan is the third-largest economy on the planet, and the Nikkei 225 is an invaluable tool in benchmarking the country’s financial situation, one that everyone looking into investing in Japanese equities must consider. It was introduced in 1950 by the Nihon Keizai Shimbun newspaper, and Nikkei Inc maintains it. Its main characteristic is its volatility. It has a history of notching massive ups and downs due to the nation’s dramatic political and economic climate changes over the decades. Without question, it also gets weighted towards industrial and technology companies, with less representation from consumer goods and financial ones.

MSCI EAFE

EAFE is short for Europe, Australasia, and the Far East. MSCI is the acronym for Morgan Stanley Capital International, a famed provider of fixed income, equity, multi-asset portfolio, real estate indexes, analysis tools, ESG, and climate products. Thus, its MSCI EAFE index measures the equity market performances outside Canada and the US. It was initially calculated at the tail end of 1969, making it the oldest international index and customarily the most reliable benchmark for foreign stocks in the United States. The Far East category here refers to Hong Kong, Japan, and Singapore, and from the Middle East, only Israeli entities get included.

A unique element of the MSCI EAFE index is its composition, as it prioritizes mid-cap and large companies. In other words, ones with a minimum market capitalization of $750 million. Know that countries can enter this index with their companies, and they can exit it, as per decisions made by MSCI. One such example is Greece, which was a part of it from 2001 when it got viewed as a developing market, but twelve years later, MSCI chose to downgrade it to an emerging one. Israel got bumped up to a developing region in 2010 and has managed to maintain this status.

To Sum Up

Anyone with a deep understanding of investing knows that stock market indexes are a vital tool for investors to track performance and benchmark their portfolio against the market as a whole.

There is little argument about what is the most widely followed index by casual traders in the US. That honor falls on the S&P 500, which keeps tabs on the activity of the top 500 large-cap companies in the country. Other indexes with similar composition criteria are The Dow Jones Industrial Average, which includes 30 blue-chip companies, and The NASDAQ Composite Index, which focuses on technology and growth companies. Concerning small-cap companies, the Russell 2000 Index tracks these. The FTSE 100 Index is the most suitable for those investing in UK companies, and the Nikkei 225 Index covers the top 225 companies in Japan. Finally, the last analyzed index above, the MSCI EAFE, provides a benchmark for international equity investments outside North America.

There is no premium choice from this batch. Each serves a different purpose and is more suitable for specific situations. Moreover, every one of these seven options listed has pros and cons. Investors must have clear trading objectives and be aware of their risk tolerance before selecting one to use as a benchmark for their portfolio. Understanding the different indexes available can aid investors in making informed trading decisions and assessing their own portfolio performance more accurately.

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