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Cosa è un indice?

Index Basics

An Introduction

The market is up, the market is down. Every night we hear about the stock markets on the news, radio, and in the paper. What does it mean when they say the markets are up? If they are up 100 points does that mean $100? Sometimes.

Today, words like Dow, S&P, and Nasdaq are a part of our everyday vocabulary. Lets take a look at what an index is and then tour though some of the major stock indexes we hear about everyday.

What is an Index?

The first and consequently most widely known index was created back on May 26, 1896 by Mr. Charles Dow. At that time the Dow index contained 12 of the largest public companies in the U.S.. Today, the Dow Jones Industrial Average (DJIA) contains 30 of arguably the largest and most influential companies in the U.S. and world economy. We will discuss the composition of the DJIA later in this tutorial.

The basic definition of an index is "a statistical measure of the changes in a portfolio of stocks representing a portion of the overall market".

Before the computer age, calculating the price of a stock market index had to be kept as simple as possible. The original DJIA was calculated by adding up the prices of the 12 companies and then dividing that number by 12. These calculations were actually more like an average than an index, but it served its purpose.

Today computers do most of the work and the indexes are much more accurate to the market. For example, many of the larger indexes now are based on the market capitalization of a company's stock rather than the stock price alone.

Each stock index is slightly different. They include different types and amounts of stock. Some are even calculated in a slightly different manner to portray a different statistical measure.

Let's take a look at some of the more popular stock indexes.

The Dow Jones Industrial Average

Today, the Dow Jones Industrial Average (DJIA) contains 30 of the largest and most influential companies in the U.S. and world economy. It is hands down the most well known index in the world, and the only one that is constantly referred to as "the market".

Created By: Charles Dow on May 26, 1896
Number of Companies: Originally 12, today there is 30.
Types of Companies: Various, the DJIA tries to cover all major areas of the U.S. Economy (technology, industrial, retail, healthcare, etc.)
Value of the Index (approx.): $9 Trillion
How it's Calculated: The original DJIA was simply an average of the stock prices. Today it uses price weightings for each stock which is adjusted for stock splits. For example, Citigroup's stock is worth approx. 3.5% of the DJIA.

Advantages: The DJIA has weathered the test of time. It contains 30 of the largest (blue chip) companies in the world therefore it is not considered to be volatile or risky.
Disadvantages: There are well over 10,000 public companies in the U.S. and the 30 companies that the DJIA contains does not even come close to being a benchmark for the entire market. For this reason the S&P 500 is beginning to takeover as the benchmark for the stock market.

The Standard & Poors 500 Index

As we just mentioned, the main problem with the DJIA is that it only contains 30 companies. The S&P 500 attempts to fix that problem by including 500 companies. As a result the index includes over 2/3 (at time of writing) of U.S. market capitalization. More and more, it is being considered to be the benchmark of the U.S. stock markets. Furthermore when mutual funds state that they have outperformed the market they are usually referring to the S&P 500.

Created By: Standard and Poor's Index Services
Number of Companies: 500
Types of Companies: Various - the S&P 500 tries to cover all major areas of the U.S. Economy. Keep in mind the S&P is not the 500 largest companies, it is the most widely held 500 companies chosen for market size, liquidity, and their industry.
Value of the Index (approx.): $12.5 Trillion
How it's Calculated: The S&P 500 is considered to be a "market-weighted index". This means every stock in the index is represented in proportion to its total market capitalization.

Advantages: The S&P 500 is one of the best benchmarks in the world. By containing 500 companies is has great diversification. The performance of the S&P 500 is considered one of the best overall indicators of market performance and mutual fund manager's goal is to beat it.
Disadvantages: The top 45 comprise more than 50% of the indexes value. Another disadvantage is there is very little foreign content.

The NASDAQ Composite Index

Similar to the S&P 500, the NASDAQ Composite Index includes a wide range of companies. The recent surge in popularity for technological stocks has launched the NASDAQ into the spotlight and the composite index is arguably one of the most followed indexes in the world.

Created By: NASD in 1971
Number of Companies: 5000+
Types of Companies: Contains all of the companies that trade on the NASDAQ. Most are technology and Internet related although there are financial, consumer, and industrial companies as well.
Value of the Index (approx.): $5 Trillion
How it's Calculated: The NASDAQ Composite is considered to be market value weighted, each company weighting is proportionate to its market value. Market value is price times outstanding shares.

Advantages: The NASDAQ Composite is heavily weighted in technology and Internet stocks. As such, the companies listed in the composite are considered to have high growth potential. Furthermore, 5000 companies in the index give it so/so diversification.
Disadvantages: One problem with the index is that it includes all the NASDAQ stocks, the good ones and the bad ones. Companies in the NASDAQ tend to be more speculative and risky than those listed on the NYSE. Because of this, the NASDAQ index is much more volatile than most other indexes.

Note: This index is not to be confused with the NASDAQ 100.

The NASDAQ 100 Index

Launched in January 1985, the Nasdaq-100 Index represents the largest non-financial domestic and international issues listed on The Nasdaq Stock Market based on market capitalization. The Index reflects companies across major industry groups including computer hardware and software, telecommunications, retail/wholesale trade and biotechnology. It does not contain financial companies including investment companies.
The Nasdaq-100 Index is calculated under a modified capitalization-weighted methodology. The methodology is expected to retain in general the economic attributes of capitalization-weighting while providing enhanced diversification. To accomplish this, Nasdaq will review the composition of the Nasdaq-100 Index on a quarterly basis and adjust the weightings of Index components using a proprietary algorithm, if certain pre-established weight distribution requirements are not met.

The Wilshire Total Market Index
(Formerly the Wilshire 5000 Equity Index)

If you thought the S&P 500 and NASDAQ Composite Index included a lot of companies, here is an even larger one. The Wilshire 5000 Index, contrary to its name, contains over 7500 stocks that trade in the U.S. Investors often refer to the Wilshire as the "total market index" because it covers such a large and wide amount of shares - it is the largest index in the world.

Created By: Wilshire Associates in 1980
Number of Companies: Currently over 7500
Types of Companies: It includes all New York Stock Exchange and American Stock Exchange issues and the most active NASDAQ issues.
Value of the Index (approx.): $15 Trillion
How it's Calculated: The Wishire is based on the market value of the companies listed in it. Market value is the stock price times the shares outstanding.

Advantages: Easily the most diversified index in the world. It pretty much covers all of the public companies in the United States.
Disadvantages: The Wilshire only contains companies that are headquartered in the U.S. leaving out many strong foreign companies. It is also similar to the S&P 500 where the top 10% of the companies in the index make up for over 3/4 of the indexes value.

The Russell 2000 Index

The previous four indexes we covered were all based on the top companies in the U.S., most of them billion dollar companies. The Russell 2000 measures the performance of smaller stocks that often get left out of the big indexes. The average market capitalization of each company in the Russell 2000 is approximately $530 million. To put that into perspective Microsoft alone has a market capitalization of over $300 billion (at time of writing).

Created By: Frank Russell Company in 1972
Number of Companies: 2000
Types of Companies: Small-cap companies from various industries. It consists of the smallest 2000 companies in the Russell 3000 index. Exclusions are stocks under $1 and pink sheets.
Value of the Index (approx.): $1.5 Trillion
How it's Calculated: The Russell 2000 is based on the market capitalization of the companies. Market cap is the stock price times the shares outstanding.

Advantages: A well diversified index for smaller companies which have great growth potential.
Disadvantages: The Russell is very streaky. When small caps come into favor with investors it tends to perform very well. But, often the index can be stuck in the doldrums for years.

What about Index Funds

These indexes are great tools for telling us what direction and trends the market is taking, how do we buy into these investment vehicles? Imagine the costs associated with buying the 7500+ stocks that make up the Wilshire or the 5000 stocks in the NASDAQ Composite. Commission fees alone would run in the tens of thousands of dollars.

Fortunately there is an easier way for individual investors to grab a piece of these indexes through an "index fund". Index funds are a portfolio of investments that are weighted the same as a stock-exchange index so as to mirror its performance.

The main advantage to an index fund is lower management fees than you would get from a regular mutual fund. The reason the costs are lower is because an index fund is not actively managed, instead fund managers only need to maintain the appropriate weightings to match the index performance. Also, the funny thing is, a majority (but not all) of mutual funds fail to outperform indexes like the S&P 500! In short, index funds offer diversity with low fees.

Some index funds can even be bought as stocks through a traditional or discount broker. For example the ticker symbol QQQ represents the NASDAQ 100, the 100 largest companies trading on the NASDAQ.

In Conclusion

So how's the market doing today? Depending on which index you look at you should be able to get a good indication of the overall health of the market, and over the long term you should be able to determine what shape the economy is in. Of the 6 different indexes we discussed many are similar, but not exact. Each one has a slight difference that tracks a different area of the market.

More importantly, investors use these indexes as a benchmark against the performance of their portfolio to see "how they performed compared to the market". If you find yourself constantly under-performing these indexes then perhaps its time to consider an index fund?