An index is a list. A list of securities.
And these securities can trade on a variety of different exchanges.
Securities have something called fungibility. Which has nothing to do with mushrooms, but everything to do with a financial instrument’s ability to be switched out with others of its kind.
Finally, an exchange is a place where securities are bought and sold. Think, New York Stock Exchange (NYSE) or NASDAQ (which originally stood for National Association of Securities Dealers Automated Quotations, but now just goes by it’s catchier acronym).
Recommended reading: You’ve Got Shares! But What is a Share Anyway?
So you’ve got stocks and bonds trading on exchanges, and an index can be created to track a particular list of a particular group of them. This is sort of like your Spotify playlist.
How’s an Index Like a Playlist?
Besides the obvious that they are both lists, this analogy can help break down how diverse indices can be.
Perhaps the most famous index is the S&P 500* (^GSPC). This is a list of the large companies whose shares are most often bought and sold (traded) on the NYSE and NASDAQ. If this were a playlist, this would be the songs that are listened to the most, regardless of genre.
The companies represented in the S&P 500 range from everything from adhesive giant 3M to tech titan Apple. 3M trades on NYSE while Apple trades on NASDAQ, but they are both represented on the S&P 500 ‘Playlist’ because of their size and trade volume.
The songs might come from a variety of genres, but they are all super popular. And we’ve all probably at least heard the tunes, even if we can’t sing the lyrics.
Other indices track entire industries like clean energy, aerospace, and fossil fuels. These playlists get a bit more specific, but still cover a lot of different artists and songs: classic rock, smooth jazz, country.
And then you can get really specific.
Your gym playlist might consist of only boy band songs from the early 2000s with pop-synth beats. Just as an index could track only companies that make stylish clothes that appear dirty, but are actually so fresh and so clean. #trendy
Why would an investment company make such a playlist or index? Because they are interested in tracking something specific. Just as you might want to listen to a 50s Holiday Crooners playlist, you might want to keep track of the performance of companies that you’re interested in and you might want to add to your portfolio.
So Who Makes an Index?
An index can be made by anyone interested in tracking a particular group of securities. However, the reputation of the index provider factors into how much weight it carries as a measure of the market, industry, or group of companies.
To return to our playlist analogy, a playlist that relies on Billboard’s Top 40 carries much more weight than Susie Smith’s Top 40, because Billboard has the data, and the reputation to be an authority on the subject.
There are several providers of indices that are considered super legit.
Quick Fun Fact: the plural of index is one of those weird English language words where there are two correct options for making it plural. Indices and Index. We’ve gone with indices. Partly because it is fun to say. In-duh-seez. Satisfying, right?
Some indices you’ve probably heard of:
The last few might be a bit more obscure to the new investor, but all are provided by organizations with lots of clout, the Billboards, Spotifies, and Pandoras of the investing world, if you will.
Indices as Market Indicators
As an investor, you can use an index to track the performance of either a broad market (think S&P 500), or a very particular industry (think clean energy or fossil fuels).
This can help you make decisions about how you would like to invest based on your interests, goals, and beliefs. Particular investments are also built around indices. Which brings me to some of our favorite finance jargon here at Stash: Exchange-Traded Funds.
Indices and Exchange-Traded Funds (ETFs)
For another rockin’ analogy to explain ETFs, check this out:
Now that you’ve got a good handle on what an index is, ETFs will be an easy addition to your jargon arsenal.
ETFs can track particular indices, and try to match their performance.
Here are a few examples of ETF investments available at Stash:
Blue Chips tracks an index (specifically the CRSP US Mega Cap Index) that represents several hundred of the biggest companies in the US. Think Top 40. Blue Chips has top exposure companies such as Apple and Microsoft, who you might say are the Beyoncé and Taylor Swifts of publicly traded companies.
Small But Mighty
You might think of Small But Mighty as potential Youtube stars. Before Bieber and Jessie J were household names, they were up and comers, just like the companies in Small but Mighty. This fund tracks the CRSP US Small Cap Index and is made up of companies like Advanced Micro Devices and Targa Resources Corporation, which you may not have heard of, yet.
American Innovators tracks investments in the technology sector. Are you thinking techno playlist? Cus we are. (Side note: One company can be tracked on a whole lot of indices. You’ll also find Apple and Microsoft here).
All That Glitters
And we couldn’t round out this roundup without the most obvious playlist of this analogy: All That Glitters**. Heavy metal is not just for your rage-out listening pleasure. Precious metals (Gold, Silver, Platinum, and Palladium) are tracked here.
As you grow and change in your investing identity, different indices may become more and less important to you, just as your listening tastes change and you grow out of some playlists.
But just as the Billboard Top 40 will keep on keepin’ a pulse on popular music, the S&P 500 keeps us up to date on the market as a whole.