In: Categories » Legal and finance » Stocks and mutual funds » How stock indexes are measured
|
An index is a statistical measure that represents the value of a batch of stocks. Investors use this measure like a barometer to track the overall progress of the market (or a segment of it). The oldest stock market index is the Dow Jones Industrial Average (DJIA or simply “The Dow”). In 1896, Charles Dow (of Dow Jones fame) created the Dow Jones Industrial Average; it covered only 12 stocks then (the number increased to 30 stocks in 1928, and it remains the same to this day). Because Dow worked long before the age of computers, he kept calculating a stock market index simple and did it arithmetically by hand. Dow added up the stock prices of the 12 companies and then divided the sum by 12. Technically, this number is an average and not an index (hence the word “average” in the name). For simplicity sake, we’ll refer to it as an index. Nowadays, the number gets tweaked to also account for things such as stock splits. However, indexes get calculated differently. The primary difference between an “index” and an “average” is the concept of weighting. Weighting is the relative importance of the items when they are computed within the index. Several kinds of indexes exist, including: Price-weighted index: This kind of index tracks changes based on the change in the individual stock’s price per share. To give you an example, suppose that you own two stocks: Stock A worth $20 per share and Stock B worth $40 per share. A price-weighted index allocates a greater proportion of the index to the stock at $40 than to the one at $20. Therefore, if we had only these two stocks in an index, the index number would reflect the $40 stock as being 67 percent (two-thirds of the number), while the $20 stock would be 33 percent (one-third of the number). Market-value weighted index: This kind of index tracks the proportion of a stock based on its market capitalization (or market value, also called market cap). Say that in your portfolio, you have 10 million shares of a $20 stock (Stock A) and 1 million shares of a $40 stock (Stock B). Stock A’s market cap is $200 million, while Stock B’s market cap is $40 million. Therefore, in a market-value weighted index, Stock A represents 83 percent of the index’s value because of its much larger market cap. Broad-based index: The sample portfolios in the preceding bullets show only two stocks — obviously not a good representative index. Most investing professionals (especially money managers and mutual fund firms) use a broad-based index as a benchmark to compare their progress. A broad-based index has the purpose to provide a “snapshot” of the entire market, such as the S&P 500 or the Wilshire 5000. Composite index: This is an index or average that is a combination of several averages or indexes. An example is the New York Stock Exchange (NYSE) Composite, which tracks all the stocks on the NYSE.
|
legal disclaimer
1) Our website is not responsible for the information contained by this article as well for any and all copyright infringements by authors and writers. E-articles is a free information resource. If you suspect this article for any copyright infringements, please read the Terms of service and contact us to investigate the problem.
2) The E-articles directory team is not responsible for inaccuracies, falsehoods, or any other types of misinformation this tutorial may contain and will not be liable for any loss or damage suffered by a user through the user's reliance on the information gained here. Please read the Terms of service
Useful tools and features
If you like this article (tutorial), please link to it from your web page using the information above. Linking to this page, this is the only way to help us improve our service, the same time providing your visitors with a way to improve their online experience.
related articles
Before you invest in a mutual fund, read the fund’s prospectus so that you understand exactly what you’re investing in. Next, fill out the online account application form for the mutual fund company. At companies like Vanguard (www.vanguard.com), depending on the type of type of account you desire, you can open an account online or print the application and mail it to the mutual fund firm. For specific details about opening an account, contact the fund company or broker. In general, you need to com...
2. Guidelines About When Is The Right Time to Sell Your Mutual Funds
If your fund becomes one of the worst performers, consider selling. However, you need to look at more than just the fund’s rating. Consider these guidelines for determining when to sell a fund: You may want to sell if you have overlapping stocks in your portfolio. (For more about overlapping stocks, see the sidebar “Checking for overlaps in your mutual funds.”) You can use the Morningstar Portfolio X-Ray feature (portfolio.morningstar.com) to discover whether the two growth mu...
3. ECNs ~ It`s Not Your Grandfather`s Market Anymore
Recent changes in SEC regulations and technology have transformed how investors interact with the stock market. I explain these changes in the following sections, and I show you how these changes enable online investors to make more money on their investments. In the following sections, you gain an understanding of what happens after you click your mouse button to execute an online trade. You also discover how you can avoid hidden transaction costs by using an electronic communications network (ECN) and how you benefit from ECNs ...
4. Mutual Fund Basics
Over the years, the stock market has outperformed any other investment. Unlike a mutual fund, however, individual investors frequently can’t purchase a large number of different securities to diversify their investment risk. Buying shares in a mutual fund solves this problem. When you invest in a mutual fund, the diversity of the portfolio reduces the risk of losing your total investment. Selecting the right fund may be difficult, but you can find plenty of online help. Assume that you have $1,000 to inves...
The Internet provides a variety of mutual fund screening tools that sort thousands of mutual funds by criteria that you select. For example, you may want one type of fund for your children’s education — something long term because you don’t need the money for 10 to 20 years — and a different fund for your retirement to help you reduce your current tax liabilities. With these online screening tools, you can evaluate several funds that meet your financial needs. Most of the stock-screenin...
6. Advantages and Disadvantages of Mutual Funds
As a general rule, the first palce to start analyzing a fund is by by comparing its expense ratio to similar funds. All funds have fees and expenses, but the amounts vary. In addition to sales and redemption fees, the mutual fund’s prospectus indicates the fund’s management and administration expenses. The fund’s investment advisor generally receives 0.5 to 1.0 percent of the fund’s average daily net assets. Administrative expenses include legal, auditing, and accounting costs, along with the f...
7. Buying Mutual Funds Online Using an Online Broker
You have many choices in how you purchase mutual funds. In addition to purchasing directly from the mutual fund company, you can purchase mutual funds through registered representatives of banks, trust companies, stockbrokers, discount brokers, and financial planners. To purchase mutual funds via the Internet, go to an online broker’s Web site. (I list a few examples later in this section.) Register by completing the online application form. You have to provide the same information you normally provide f...
8. What you have to know to determine the fair value of a stock and the right price
You can use several methods to determine the fair value of a stock. Throughout the following sections, I discuss three of the more popular methods of determining the right price for a stock: Fundamental analysis Technical analysis Market timing Valuing securities is important to your financial health. Stocks are more difficult to value than bonds. Bonds have a limited life and a stated payment rate. Common stocks don’t have a limi...