The equity market includes several segments; indices capture the movement of these segments by concentrating on a sector, region, country, or cluster of any of them. With mutual funds and ETFs providing an easy way to track such indices, an investor may or may not be aware of the constituents of the indices and thereby, lack an understanding of what they hold. The following is a look at the major stock indices to provide a basic idea of the vast world of equity indices. One or more ETFs (links) that track each index are also provided.
The Dow Jones Industrial Average (DJIA) Index
The DJIA, or simply the Dow, is one of the principal stock market indices of the US and popular all over the world. Generally, when news channels talk about market swings, they are referring to the movement of the Dow and the S&P 500 in the US and the S&P/TSX Composite in Canada. The DJIA shows the performance of 30 large, publicly-traded companies based in the United States. The Dow Jones is a price-weighted index; that is, the index is calculated by adding the per share price of the 30 stocks of the index and dividing this total by the number of companies (30). However, with the passage of time, this calculation has gotten tedious due to stock splits, spin-offs, and stock dividends. Hence, to account for such events, a scaled average is employed, which uses a divisor that changes as and when new events such as stock splits occur.
Despite the Dow comprising 30 large cap stocks, a certain percentage change in the Dow cannot be definitively interpreted to mean that the overall stock market changed by that same percent, since the DJIA is a price-weighted index. E.g. A $1 change in the price of a $100 stock in the index will have the same impact on the Dow as a $1 change in the price of a $25 stock, even though one stock may have changed by 1.0% and the other by 4.0%. However, movement in the Dow Jones is a reasonable indicator of stock market momentum, though not necessarily on the same scale.
The SPDR Dow Jones Industrial Average ETF and the BMO Dow Jones Industrial Average Hedged to CAD Index ETF are two ETFs that track this index.
The S&P 500 Index
Typically, when investors and fund managers want a benchmark to compare their US stock portfolio performance, they turn to the S&P 500 index. The S&P 500 is considered as the single best gauge of the US equities market by covering over 70% of the total value through its 500 large cap stocks across different sectors (namely, consumer staples, energy, financial, health care, industrial, and information technology). It gives a better indication of the movement of the US stock market due to the diversity of its constituents. The S&P 500 index is capitalization-weighted (also known as market-weighted); that is, every stock in the index is represented in proportion to its total market value (market capitalization = number of outstanding shares * current share price). Therefore, a 10% drop in the total capitalization of the 500 companies would result in a 10% decline in the index value. Due to computations based on percentages than absolute dollar amounts, the S&P 500 serves as a better comparison tool.
The S&P/TSX Composite Index
The S&P/TSX Composite Index consists of the largest capitalization-weighted companies incorporated under Canadian laws and traded on the Toronto Stock Exchange. This index is the Canadian equivalent of the S&P 500 Index and offers broad market exposure. Within the S&P/TSX Composite Index family, there are four classes – Equity Indices, Income Trust Indices, GICS® (Global Industry Classification Standard) Indices, and Market Cap Indices; refer to the TMX Group page for detailed reading (click on the D under Index Information for S&P/TSX Composite Index). There are over 240 companies that constitute the index with the financial, energy, and materials sectors accounting for ~76% of them.
The iShares S&P/TSX Capped Composite Index Fund can provide similar exposure.
The S&P/TSX 60 Index
The well-known S&P/TSX 60 Index is a sub-class of the S&P/TSX Composite Index and provides a portfolio index to capture both the Canadian large cap market and sector weights of the stock market.
The iShares S&P/TSX 60 Index Fund can provide equivalent exposure.
The Nasdaq Composite Index
The Nasdaq Composite is a market-capitalization weighted index that comprises of all companies traded on the Nasdaq exchange with restrictions to exclude certain instruments such as preferred stocks and derivatives. There are over 2800 companies that trade on the Nasdaq market involving US-listed common stocks, American Depository Receipts and REITs. The index is heavy in technology stocks with financial, industrial and biotechnology sectors also represented.
The Fidelity Nasdaq Composite Index Tracking Stock Fund is available to track this index. Canadian investors have the NASDAQ 100 Index Fund (CAD-Hedged) but note that this ETF tracks the NASDAQ-100 Index which only includes 100 of the largest non-financial securities (domestic and international) listed on the Nasdaq Exchange.
The Russell 2000 Index
The Russell 2000 Index is a capitalization-weighted index that includes the 2000 smallest stocks of the US market. This index is a subset of the Russel 3000 Index covering about 8% of that index. The top three sectors of the Russell 2000 Index are financial services, technology, and consumer discretionary. Small cap stocks are known for their volatility though they have managed to outperform the S&P 500 in the past.
The MSCI EAFE Index
This Morgan Stanley Composite Index represents the international developed stock markets outside North America, specifically Europe, Australasia, and the Far East. It is a capitalization-weighted index that covers the stock markets of Germany, Australia, Japan and United Kingdom to name but a few; the entire list is available on the MSCI web page.
As an investor, have you covered all the above equity indices in your portfolio, be it in the form of individual stocks (tough to do for all indices), mutual funds or ETFs? Have you made your life easier by simply buying the S&P Total Market Index (VTI) to cover all bases in the US? Have you ventured into emerging markets territory?
About the Author: Clark works in Saskatchewan and has been working to build his (DIY) investment portfolio, structured for an early retirement. He loves reading (and using the lessons learned) about personal finance, technology and minimalism. You can read his other articles here.
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