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Money Management
USING INDEXES TO TRACK THE MARKET AND YOUR
INVESTMENTS
November 20, 2000
Stock market indexes serve many different purposes. There
are indexes that track the performance of stocks in particular industries and those that measure stocks in different
countries. There are indexes for small companies, large companies, and those in between. The New Jersey Society
of Certified Public Accountants (NJSCPA) offers the following information on stock indexes to help you become a
wiser investor.
Stock indexes are groups of stocks that are selected, assembled together, and given a weighing relative to the
rest of the stocks in the group. In calculating the index's return, the stocks in most major indexes are weighed
by market value (stock price times shares outstanding). The higher the stock's market value, the more its performance
counts.
Indexes can provide a quick snapshot of how particular types of stocks fare and perform in comparison to other
types of stocks. Knowing your way around the more common indexes is especially important in today's market where
returns can vary widely from one sector of the market to another. Indexes also provide an important historical
perspective of the market.
Many mutual funds measure their results against the performance of a particular index. For instance, a mutual fund
that invests in large companies might use the Standard & Poor's (S&P) 500 as a benchmark for communicating
its performance to potential investors. You should use indexes to compare or benchmark the performance of your
stock market investments and to determine how your investments are doing.
For an accurate assessment, it is important to know which index is most representative of your stock holdings.
For example, if you invest primarily in large company U.S. stocks, you should compare the overall return of the
stocks in your portfolio to a comparable index - in this case, the S&P 500. If, on the other hand, your investment
interests lean more toward the stock of smaller companies, the Russell 2000 might be a better barometer.
Here's a description of some of the major U.S. stock market indexes.
Dow Jones Industrial Index - The "Dow" as it is popularly known, tracks the performance
of thirty large, blue chip companies. Started back in 1896 with just 12 stocks, the Dow now represents a range
of industries that have evolved over the years to reflect shifts in American industry. Companies like American
Cotton Oil and Tennessee Coal & Iron have been replaced with the likes of Disney, Coca-Cola, AT&T, Microsoft,
and Home Depot. Unlike most indexes that are market-cap weighed, in the Dow, each stock's weight is based on its
price.
Standard & Poor's 500 Index - The S&P 500 index, a widely followed benchmark of stock market
performance, tracks 500 companies of all sizes from all industries that are chosen by S&P to represent the
full spectrum of American business. The S&P 500 is a much broader and more representative index of the larger
company stocks in the U.S. than is the Dow.
NASDAQ Composite - Today, the widely followed NASDAQ Composite index tracks all the stocks listed on the NASDAQ market.
Because there are many high-tech companies on the NASDAQ, it has become a respected gauge of how tech stocks are
doing.
Russell 2000 Index - The Russell 2000 tracks the performance of 2000 smaller U.S. company
stocks spanning a range of industries. If you invest in small cap stocks or funds, when comparing the performance
of your portfolio to the Russell 2000 index, you should bear in mind that smaller company stocks tend to be more
volatile than the stocks of large companies, often rising higher when the stock market increases and falling further
when the market declines.
Wilshire 5000 Total Market Index - The Wilshire 5000 represents the publicly traded stock of all companies
headquartered in the United States, and is considered by many to be the index that is the broadest and most representative
of the overall U.S. stock market. Despite its name, there are currently more than 7000 companies in the index.
If you want to compare your portfolio against that of all other investments in U.S. stocks combined, the Wilshire
5000 is your best bet.
CPAs say that utilizing the major stock market indexes can provide valuable insights into what's really going on
in the market as well as your own portfolio.
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Money Management is a weekly column on personal
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