What is a Stock Market Index?

Earlier this week, I taught my Rutgers Personal Finance class about stocks, stock indexes, and index funds. You have probably heard the Dow Jones Industrial Average (a.k.a., “the Dow”) index reported during evening news broadcasts. The Dow is a price-weighted average of the value of 30 large U.S. companies. It was invented in 1896 by Charles Dow to report how well the stock market is doing and to show trends in market performance.

The Dow is just one of many indexes used to track stock market performance. There are also indexes for bonds. An index is an unmanaged collection of securities. The securities are changed periodically based on company performance and industry trends. Below are four commonly used domestic stock market indexes:

¨     Dow Jones Industrial Average- Tracks 30 large U.S. companies and widely reported by news media outlets.

¨     Standard & Poor’s 500- Tracks 500 large U.S. companies and widely used as a benchmark for U.S. stock market performance

¨     Russell 2000- Tracks small U.S. companies (a.k.a., small capitalization or “small cap” stocks).

¨     Wilshire 5000- Tracks virtually all listed stocks that are actively traded in the United States.

Investors can use stock indexes in two ways:

¨     Buy index funds- Index funds are mutual funds that track a particular stock (or bond) index. They buy all of the securities in an index, or a representative sample of it, and provide approximately the same performance.

¨     Benchmark investment performance- The earnings of actively managed (non-index) mutual funds and individual stocks can be compared to stock indexes for an objective gauge of returns relative to market trends.