Rip Van Winkle investing

By Selwyn Gerber:

The S&P 500 index was originally market-value weighted. That means the price of each stock is multiplied by the number of shares issued by the company to find the market cap of the stock. Market caps are summed, and that total was divided by 500 in this case. This gives large cap stocks more impact on the index than companies whose market valuation is smaller.

Asset Management

Recently, the index calculation method was changed to float weighted. Standard & Poor’s determines the number of shares that are actually available for public trading, a number known as the float, and multiplies the float times the share price. These values are summed and the total divided by 500. This minimizes the impact of technology companies, which often have a large number of shares owned by employees but unavailable for trading and minimizes the chances that another internet bubble could drive the index to unsupportable levels. However in general the S+P 500 is considered to be a market capitalization weighted index,as opposed to the other weightings such as equal weighted or weightings based on a total economic footprint of the respective companies.

Exchange Traded Funds

The Nasdaq Composite is a stock market index of all of the stocks listed on the NASDAQ (National Association of Securities Dealers Automated Quotation System) stock market, meaning that it has over 3,000 components. It is widely followed in the U.S. as an indicator of the performance of technology and growth stocks. Since both U.S. and non-U.S. companies are listed on the NASDAQ stock market, the index is not an exclusively U.S. index. It was launched in 1971 with a base value of 100. The index is calculated using market caps to weight each stock.

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Another group of indexes is published by Russell Investment Group. In 1984 Russell recognized that existing indexes, like the Dow and S&P 500, did not represent the investments that most managers were making. In other words, the indexes were flawed and this explained the inability of active managers to beat the market. The company developed new rules-based indexes to better measure the performance of what they termed “investable stocks.” Their goal was create indexes that would be used as the basis for mutual funds and other financial products.

Russell has been very successful, and many mutual funds, ETFs and futures contracts are based on their indexes. They also created indexes for global markets. Russell claims that more money is indexed using their indexes as a benchmark than for any other index family.

Their main U.S. index is the Russell 3000 Index, which includes the top 3,000 stocks measured by market cap. The top 1,000 of those companies make up the large-cap Russell 1000 Index, and the bottom 2,000 (the smallest companies) make up the small-cap Russell 2000 Index.
The Russell Global Index reflects the performance of nearly 11,000 stocks worldwide, including the Russell 3000 Index as its U.S. component and the Russell/Nomura Total Market Index as the Japan component.

Russell also publishes Value and Growth versions of each U.S. index. This divides each index approximately in half, separating companies classified as value stocks from those classified as growth stocks.

The humble origin of the stock market index, nearly a century ago, was as a tool for forecasting and monitoring the economy. Since then, however, the index has evolved into a powerful method of constructing investment vehicles. By taking the guesswork out of selecting investments and rolling the whole economy into one basket, indexes allow anyone to take advantage of Bogle’s corollary; “Don’t look for the needle in the haystack. Just buy the haystack.” It also allows the investor to select a particular slice of the U.S. or global economy in which to invest.