Indices: the market in one number

One number for many shares

Thousands of companies’ shares trade in the US every day. On any day some go up and some go down. To answer a simple question — “how did the market do today?” — people need one number that sums up many shares.

That number is an index. It follows the prices of a chosen list of shares and combines them into a single figure. When the list’s shares rise in value overall, the index rises; when they fall, it falls.

An index is measured in points, not in dollars. A level like 5,000 or 20,000 means little by itself. What matters is how it changes: “the index rose 1% today” or “it is 12% higher than a year ago”.

The three you will hear about

The S&P 500. The S&P 500 follows about 500 large US companies, across every industry. A committee at the company that runs it decides which companies are in, using rules about size, trading and profits, and changes the list from time to time. Because it covers a large part of the value of the whole US market, it is the index most people mean when they say “the US market”.

The Nasdaq-100. The Nasdaq-100 follows the 100 largest companies listed on the Nasdaq exchange, leaving out banks and other financial companies. Many of the biggest technology companies are listed on Nasdaq, so this index leans heavily towards technology.

The Dow. The Dow Jones Industrial Average is the oldest of the three and the smallest: 30 large US companies. It is calculated in an old way — by share price, not company size — so a company with a $400 share moves it more than one with a $100 share, whichever company is bigger. It is still widely quoted, but it says less about the whole market than the S&P 500.

Why weighting matters

The S&P 500 and the Nasdaq-100 are weighted by market cap. A company worth ten times more than another counts ten times as much in the index. So the largest companies move these indices the most, and on some days a handful of them decide the direction of the whole number.

This is worth keeping in mind when you read the news. “The S&P 500 rose today” does not mean most companies rose. It means the companies’ value, added up by size, rose.

Price, or price plus dividends?

The S&P 500 figure in the news counts only price changes. The companies in it also pay dividends, which an investor receives on top. Some indices have a second version, often called a total return index, that adds the dividends back in. When you compare your own return with an index, check which version you are looking at.

You cannot buy an index — but funds follow one

An index is only a calculation; there is nothing to buy. To get roughly what an index earns, investors buy a fund that holds the same shares in the same proportions. Such a fund is called an index fund. Many of them are ETFs, which trade on an exchange like a share.

One purchase of such a fund spreads your money over every company in the index — a ready-made form of diversification. The fund charges a yearly fee, its expense ratio, so its return is the index’s return minus that fee, and minus small differences in how closely it follows. The Funds and ETFs path explains these in detail.

Indices as a yardstick

Because an index shows what a whole group of shares did, people use it as a yardstick, called a benchmark. If your shares rose 8% in a year in which the S&P 500 rose 15%, you made money, but less than a simple index fund would have made. The Measuring path returns to this in Did you beat the market?

In short

An index turns the prices of many shares into one number. The S&P 500 follows about 500 large US companies, the Nasdaq-100 the 100 largest non-financial ones on Nasdaq, and the Dow 30. The first two are weighted by market cap, so the biggest companies move them most. You cannot buy an index, but an index fund or ETF follows one, for a fee.