When it comes to investing your money, knowing the major stock market indexes are key to understand your investments and performance.
There are two simple reasons why you should know what each market index measures:
- know how an index fund is invested
- make an exact performance comparison
The first is fairly straight forward. To better understand how an ETF or index fund works, just research the index it tracks. It will tell you the stocks in the fund, how the money is invested and adjusted based on the weighting method of each index. And it should give you a good idea if it fits within your risk tolerance.
The second keeps you, fund managers and advisers honest. I’m not calling you a liar. But when someone says they beat the market, the assumption is they beat the S&P 500. That’s great. Unless they were invested in bonds! Or small cap stocks! Or emerging market stocks! Basically nothing resembling the make up of the S&P 500.
The best way to compare your investment’s performance is against a similar stock market index. This way, you’ll know if that stock or fund is performing up to par. And if not, you can find something better.
List of Stock Market Indexes
Dow Jones Industrial Average
As the first and oldest index, the Dow gets the respect it deserves. Its historical relevance makes it the most recognized and quoted index. Yet, because of how it’s built, few people view it as a benchmark or comparison tool. Despite the fact it has held up rather well in tracking the overall market.
The Dow is made up of 30 large cap stocks and is a price weighted index. Which means it is based on a stock’s share price. Higher priced stocks make up a larger part of the index. Price alone doesn’t tell us much about a company. So it’s easy to have potential problems when a $100 stock gets 10 times more weighting than a $10 stock. This is why price weighted indexes are rare.
The Dow’s small sample size and price weighting are it’s biggest criticisms. Which is why most people use the S&P 500 as a large cap benchmark.
S&P 500 Composite Stock Price Index
Widely known as the S&P 500, this index is the comparison to use for large cap stocks and funds. It’s also the most popular benchmark index for index funds and ETFs. If you have an S&P 500 index fund in your portfolio or it’s an option in your retirement account, this is the index it tracks. Just compare that fund to the S&P 500 and you’ll have good idea if you’re getting your money’s worth. If it falls short, you might want to look for a better alternative.
The S&P 500 is made up of (shocker!) 500 stocks and is a market cap weighted index. Market cap is the total value of a company. So, a larger market cap stock will represent a larger part of the S&P 500. But because of how market weighted indexes work, as a company’s market cap (and stock price) rises, the S&P 500 puts more weight on that stock. It’s not a perfect weighting method, but at least market cap is a better sign of a companies health than stock price.
Wilshire 5000 Total Market Index
Total market funds have become a popular investment choose lately. Those funds are based off the Wilshire 5000 index. This index measures the performance of the entire U.S market. It’s made up of every U.S. based stock and uses a market cap weighting.
Despite’s its name, the Wilshire 5000, has over 5000 stocks in the index. If you have a total market fund or a U.S. fund, use this index as a performance comparison.
Russell 2000 Index
The Russell 2000 index is made up of the 2000 smallest stocks in the Russell 3000 index. It’s market cap weighted and measures the performance of 2000 U.S. based small cap stocks.
To keep larger market cap stocks from having to much influence on the index, every year the larger stocks that don’t meet the small cap status are filtered out. The Russell 2000 is the perfect performance comparison for small cap stocks and funds.
MSCI EAFE, or Morgan Stanley Capital International Europe, Australasia, Far East index, is made up of popular international stocks. Several ETF and index funds are built using this index. It’s actually made up of 22 country specific indexes from the developed world outside of North America. That includes small, mid, and large cap stocks across multiple sectors and industries.
The MSCI EAFE is the best benchmark to measure performance for international funds or stocks from the developed world. However, if you invest in country specific funds, its best to use that country’s index.
MSCI Emerging Markets Index
One way to diversify internationally is through emerging markets. The MSCI Emerging Market Index is the benchmark for several ETFs and index funds. It’s a market cap weighted index made up of over 2,700 stocks from 21 emerging market countries. It includes a combination of small, mid, and large cap stocks across multiple sectors in each market.