If you are not familiar with stock indexes then please read this post which explains what they are first. What is a stock index?
Stock indexes come in a variety of shapes and sizes. The most common types of stock indexes are market value-weighted (S&P500) and price-weighted indexes (Dow Jones). Some determining factors of various indexes include how many companies and which type of companies they cover. In theory an index could include every company that trades publicly or any subset of those companies.
- All company – Dow Jones Wilshire 5000 is an index of every publicly traded stock in the United States.
- Rank by size – Some indexes include just the largest companies according to the value of the company. The Russell indexes include only the largest companies by value ie the Russell 1000 includes the largest 1000 publicly traded U.S. companies.
- Covering a specific sector – A sector refers to the industry that a company is in. An example of a sector index would be the Dow Jones U.S. Financial Sector Index which includes companies from the financial services sector of the U.S. equity market such as banks and mutual fund companies.
- Rank by both – ie S&P 500 has the top companies by size in each major industry.
Can companies be added to or deleted from an index?
Regardless of how an index is put together, companies can be added or removed from the index. If a company on an index goes out of business or is taken over by another company then it will be deleted from the index. Conversely a company will be added to the index once it is meets the index requirements.
Why do I need to know this?
If you invest in index funds or ETFs this information is useful because most index funds and ETFs will base their investments on an stock/bond index of some sort. It’s important to understand what the underlying index is based on and to make sure it fits your investment objectives. You wouldn’t want to buy an index fund which only covers forestry companies when you actually wanted a broad-based index funds covering all the larger companies in the US.
How to find out more about the indexes behind your investments
There are plenty of good sources for this information but I use Morningstar which is one of the leaders in financial information. You can sign up for a free membership at Morningstar here or click on the banner below.