When you invest in funds, knowing the different stock market indexes is key to building a portfolio and tracking its performance. There are two basic reasons why you should know what each index measures:
- to know how an index fund invests
- to make a performance comparison
This is because you’re either invested in index funds or picking mutual funds that try to beat an index.
The first point is fairly straight forward. To better understand how an index fund works, just research the index it tracks.
The index tells you the type of stocks in the fund and how the fund invests based on the rules laid out. Just knowing those two things should give you a good idea if it fits in your portfolio or not.
The second keeps fund companies, fund managers, and advisers honest. When someone says they beat the market, the assumption is they beat the S&P 500. That’s great, unless they’re invested in bonds! Or small cap stocks. Or emerging market stocks. You get the idea – nothing resembling what’s in the S&P 500.
The best way to compare your fund’s performance is against similar stock market indexes. For index funds this is easy. Compare its performance to the index it tracks.
For managed mutual funds you should compare based on the type of stocks in the fund. When you find a fund not living up to the index’s performance, its time to find a better fund.
The list below covers the more popular stock market indexes, the funds you can compare it to, and alternative indexes that track a similar basket of stocks.
U. S. 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 tracks 30 large cap stocks and is a price weighted index. Which means it’s based on a stock’s share price. Higher priced stocks make up a larger part of the index.
Price alone doesn’t tell you 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. This is why the S&P 500 is the stock market benchmark.
S&P 500 Index
- Comparison: Large Cap Stock Funds
- Alternative: Russell 1000, CRSP U.S. Large Cap Index
The S&P 500 is the most popular stock market benchmark. 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 a 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 tracks 500 stocks and is a market cap weighted index. Market cap is the total value of a company. So, a larger market cap stock makes up 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 price alone.
Russell 2000 Index
- Comparison: Small Cap Stock Funds
- Alternative: S&P 600, CRSP U.S. Small Cap Index
The Russell 2000 index tracks the 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 too 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 stock funds.
Wilshire 5000 Total Market Index
- Comparison: U.S. Total Market Stock Funds
- Alternative: Russell 3000, CRSP U.S. Total Market Index, MSCI U.S. Broad Market Index, Dow Jones U.S. Total Market Index
Total market funds have become a popular investment choose lately. Those funds are based off the Wilshire 5000 index and similar alternatives. 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, use this index as a performance comparison.
MSCI U.S. REIT Index
- Comparison: REIT Funds
- Alternative: FTSE NAREIT U.S. Real Estate Index, S&P U.S. REIT Index
REIT funds are finding a place in the average portfolio. There are several indexes used by these funds. The MSCI U.S. REIT Index is one of the more popular indexes built to track the performance of a basket of U.S. REITs. The index is cap weighted and built to represent about 85% of the U.S. REIT market.
International Stock Market Indexes
MSCI EAFE Index
- Comparison: International Developed Stock Funds
- Alternative: FTSE Developed ex America
MSCI EAFE, or Morgan Stanley Capital International Europe, Australasia, Far East index, tracks international stocks from developed countries. Several ETF and index funds are built around index.
This index is made up of 21 country specific indexes from the developed world outside of North America (no U.S. or Canadian stocks). That includes small, mid, and large cap stocks across multiple sectors and industries.
There are several subsets of this index that exclude specific countries, like the MSCI EAFE ex Japan (excludes Japanese stocks), which allow funds to focus on specific areas of the world.
The MSCI EAFE is the best benchmark to measure performance for international funds investing in the developed markets. However, if you invest in country specific funds, MSCI has country specific indexes too.
MSCI Emerging Markets Index
- Comparison: Emerging Market Stock Funds
- Alternative: FTSE Emerging 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 stocks from 23 emerging market countries. It includes a combination of small, mid, and large cap stocks across multiple sectors in each market.
Like the MSCI EAFE, you’ll find several funds built around a subset of this index which exclude specific countries to focus on different parts of the world.
MSCI ACWI Index
- Comparison: Global Stock Funds
- Alternative: FTSE Global All Cap Index
The MSCI ACWI (All Country World Index) is built to benchmark global stock market performance and is the primary index used by global stock funds. The index includes over 9,000 stocks from 46 countries – all the countries in the MSCI EAFE and Emerging Markets Indexes along with the U.S. and Canada.
Like the other international indexes, a subset of this global index is used, like the MSCI ACWI ex U.S. (excludes U.S. stocks), to build index funds around.