How Indexes Can Give You Insight to ETF Investment Vehicles - dummies

How Indexes Can Give You Insight to ETF Investment Vehicles

By Paul Mladjenovic

For stock investors, ETFs that are bullish or bearish are ultimately tied to major market indexes. You should take a quick look at indexes to better understand them (and the ETFs tied to them).

Whenever you hear the media commentary or the scuttlebutt at the local watering hole about “how the market is doing,” it typically refers to a market proxy such as an index. You’ll usually hear them mention “the Dow” or perhaps the “S&P 500.” There are certainly other major market indexes, and there are many lesser, yet popular, measurements, such as the Dow Jones Transportation Average.

Indexes and averages tend to be used interchangeably, but they’re distinctly different entities of measurement.

Most people use these indexes basically as standards of market performance to see whether they’re doing better or worse than a yardstick for comparison purposes. They want to know continuously whether their stocks, ETFs, mutual funds, or overall portfolios are performing well.

You can find great resources online, such as Dow Jones, that give you the history and composition of indexes. For your purposes, these are the main ones to keep an eye on:

  • Dow Jones Industrial Average (DJIA): This is the most widely watched index (technically it’s not an index, but it’s utilized as one). It tracks 30 widely owned, large cap stocks, and it’s occasionally re-balanced to drop (and replace) a stock that’s not keeping up.

  • Nasdaq Composite: This covers a cross-section of stocks from Nasdaq. It’s generally considered a mix of stocks that are high-growth (riskier) companies with an over-representation of technology stocks.

  • S&P 500 index: This index tracks 500 leading, publicly traded companies considered to be widely held. The publishing firm Standard & Poor’s created this index.

  • The Wilshire 5000: This index is considered the widest sampling of stocks across the general stock market and, therefore, a more accurate measure of stock market movement.

If you don’t want to go nuts trying to “beat the market,” consider an ETF that closely correlates to any of the indexes mentioned in the preceding list. Sometimes it’s better to join ’em than to beat ’em.