What is an index?
Generally speaking, an index is an indicator or measure of something. In simple terms, in the world of investing, an index is a hypothetical portfolio of securities designed to represent an asset class, market, or market segment.
How are indexes used?
- Indexes play an important and informative role at every step of the investment process. • Economists use them to analyze economic trends.
- Individual investors make decisions based on economists’ outlooks.
- Institutional investors use indexes to conduct risk analysis, develop investment policies, and create asset allocation strategies.
- Nearly all types of investors use them to evaluate the performance of their investment portfolios.
Indexes are also used as a basis for investable products such as mutual funds or ETFs that allow for passive investment in a specific market, market segment, or asset class.
How are index constituents chosen?
To deliver an unbiased, complete view of a given market, the method by which an index’s constituents are selected must be free of subjectivity, as the index should include all of the practical opportunities available in the market.
An objective, rules-based formula for determining which companies become components of the index (as opposed to a hand-selected sample) is a critical component of the construction methodology of a truly representative index.
For example, if an index designed to represent the large cap segment of a given market omits some of the large cap companies readily available to market participants, and that index is being used to define the basket of stocks from which an investment manager may select, the resulting large cap portfolio could be left without exposure to important drivers of the large cap market.
Disclosure: Interactive Brokers
Information posted on IBKR Traders’ Academy that is provided by third-parties and not by Interactive Brokers does NOT constitute a recommendation by Interactive Brokers that you should contract for the services of that third party. Third-party participants who contribute to IBKR Traders’ Academy are independent of Interactive Brokers and Interactive Brokers does not make any representations or warranties concerning the services offered, their past or future performance, or the accuracy of the information provided by the third party. Past performance is no guarantee of future results.
This material is from FTSE Russell and is being posted with permission from FTSE Russell. The views expressed in this material are solely those of the author and/or FTSE Russell and IBKR is not endorsing or recommending any investment or trading discussed in the material. This material is not and should not be construed as an offer to sell or the solicitation of an offer to buy any security. To the extent that this material discusses general market activity, industry or sector trends or other broad based economic or political conditions, it should not be construed as research or investment advice. To the extent that it includes references to specific securities, commodities, currencies, or other instruments, those references do not constitute a recommendation to buy, sell or hold such security. This material does not and is not intended to take into account the particular financial conditions, investment objectives or requirements of individual customers. Before acting on this material, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.
Disclosure: Stock Symbols
Any stock, options or futures symbols displayed are for illustrative purposes only and are not intended to portray recommendations.