The World of Stock Market Indices: A Simple Guide
Stock market indices are like scorecards that track how groups of companies are performing. They're a quick way to see if the market is doing well or poorly. Let's explore their history, how they work, and what they mean for investors.
The Birth of Stock Market Indices
Stock market indices began in the late 19th century as a simple way to measure market performance. The very first one was created by Charles Dow in 1884, when he averaged the prices of 11 important stocks to create what eventually became the Dow Jones Industrial Average.
Before indices, investors had no easy way to gauge the overall market - they could only look at individual companies. Indices changed that by giving a snapshot of broader market trends.
Popular Stock Market Indices Around the World
USA
Dow Jones Industrial Average (DJIA): started in 1896, now tracks 30 large American companies.
S&P 500: follows 500 of the largest US companies and is considered more representative of the US market than the Dow.
Nasdaq Composite: heavily weighted toward technology companies.
UK
FTSE 100: tracks the 100 largest companies listed on the London Stock Exchange.
FTSE 250: follows the 101st to 350th largest companies and often reflects the UK economy more than the FTSE 100.
FTSE All-Share: combines the FTSE 100, FTSE 250, and FTSE SmallCap indices.
Europe
EURO STOXX 50: represents 50 of the largest companies across the Eurozone.
DAX: Germany's main index, tracking 40 major companies.
CAC 40: France's benchmark index of 40 significant stocks.
Japan
Nikkei 225: Japan's oldest stock index, similar to the Dow Jones.
TOPIX: tracks all companies in the First Section of the Tokyo Stock Exchange.
What Do the Numbers Mean?
When you hear "the FTSE is up 20 points today," it means the total value of the index has increased by 20 points from its previous closing value.
For example:
If the FTSE 100 closed at 7,500 yesterday and is now at 7,520, it's up 20 points.
This represents a 0.27% increase (20 ÷ 7,500 = 0.0027 or 0.27%).
A 100-point move on the FTSE 100 today is less significant than it was years ago, when the index value was lower. That's why percentage changes give a better picture of market movements.
How Indices Work
Different indices calculate their values in different ways:
Price-weighted indices (like the Dow Jones): companies with higher share prices have more influence, regardless of their size.
Market cap-weighted indices (like the S&P 500 and FTSE 100): larger companies have more influence than smaller ones.
Equal-weighted indices: all companies have the same influence, regardless of size.
Most major indices are rebalanced regularly, adding or removing companies to make sure they remain representative of their markets.
Investing in Indices
You can't directly buy an index, but you can invest in them through:
Index funds: mutual funds that buy shares in all the companies in an index.
Exchange-Traded Funds (ETFs): similar to index funds but traded like shares.
Index trackers: products designed to match the performance of a specific index.
Advantages of Index Investing
Diversification: your money is spread across many companies, reducing risk.
Lower fees: index funds typically have lower management fees than actively managed funds.
Simplicity: you don't need to research individual companies.
Reliable long-term returns: major indices have historically grown over time.
Downsides of Index Investing
Limited growth: you'll never beat the market since you're simply matching it.
No protection in downturns: when the market falls, your investment falls with it.
No control over investments: you might be investing in companies you don't support.
Different growth rates: xome indices grow faster than others, so choosing the right one matters.
What Affects Index Values?
Many factors can make indices rise or fall:
Economic news (growth figures, unemployment rates)
Interest rate changes
Political events (elections, Brexit)
Global events (pandemics, wars)
Company news (earnings reports, scandals)
Starting Your Index Investment Journey
If you're interested in investing in indices:
Decide which index matches your goals (UK-focused? Global? Technology?)
Choose how to invest (through a stocks and shares ISA, pension, or investment account)
Pick an index fund or ETF with low fees
Consider regular investments rather than lump sums
Be prepared for ups and downs, focusing on long-term performance
Remember that while indices have historically grown over time, past performance doesn't guarantee future results.