If you follow the news regularly then you have probably heard of the “Dow Jones” index and maybe the “S&P 500” index. Let’s take a look at what a stock market index is and why you should know about them.
An stock market index (or just “index) is a number that measures the relative value of a group of stocks. As the stocks in this group change value, the index also changes value. If an index goes up by 1% then that means the total value of the securities which make up the index have gone up by 1% in value.
The most common indices such as the Dow Jones Industrial Average, are made up of stocks but there are indices of bonds, real estate and others. Usually the index value is termed “points” – as in “the Dow Jones dropped 500 points today”. This means that the index went from a value of perhaps 4000 points to a value of 3500 points. The points don’t mean anything – the best way to look at an index number is to compare it with a previous value such as the previous day’s number.
Example of stock market index
The ABC index is made up of four companies. As of the end of yesterday’s trading day the ABC index was set at 4,123 points. Today, two of the companies went up in value, one company dropped in price and the fourth company stayed the same – the total value of those stocks went up by 2% so the ABC index is now 2% higher or 4205 points.
Why are indexes important?
If you invest in mutual funds or individual stocks then it’s important to measure the performance of your investments against a relevant market index. If your investments consistently lag behind the index then it might be time to come up with a new investing strategy.
I recommend signing up for a free Morningstar membership, which will allow you to research more about stocks and other investments.