What is an Index?

A stock market index is a way of measuring the performance of a group of stocks as a whole. Instead of tracking one company, it tracks many at once and gives you a single number that represents how that group is doing.

How is an index constructed?

An index starts with a set of rules. Maybe it tracks the 500 largest companies in the United States, or the 100 largest in the United Kingdom, or every company listed on a particular exchange. The companies that qualify are included. Those that no longer qualify are removed. The index is updated regularly to reflect these changes.

How is the number calculated?

Most modern indexes are weighted by market cap. This means larger companies have a bigger influence on the index number than smaller ones. If Apple has a much larger market cap than a smaller company in the same index, a move in Apple's stock will affect the index more.

Why are indexes useful?

They give you a benchmark. Instead of asking "did my investment do well?", you can ask "did my investment do better than the market?" If the index returned 10% last year and your portfolio returned 7%, you underperformed. If you returned 13%, you outperformed.

Can you invest in an index?

You cannot buy an index directly, but you can invest in funds that track one. These are called index funds or ETFs. They are one of the most popular and cost-effective ways for ordinary investors to participate in the stock market.