Financial Educator
What is an index?
An index is a way of measuring the performance of a market over time. For example, a stock market index is a sample basket of stocks that represent the change in value of the market as a whole, in much the same way that inflation is measured by comparing the cost of a basket of goods over time.
There are three main types of equity market indices, each fulfilling a different role.
A performance benchmark measures the performance and risk of a broad market; generally, it will cover 80% to 90% of a market's capitalisation.
Performance benchmark constituents will have a sufficient level of market capitalisation combined with high liquidity, enabling institutions to move in and out of the stock without adversely affecting the share price.
A tradeable benchmark may also be a performance benchmark, however this type of index also forms the basis for various derivative products. A tradeable benchmark is designed to be narrow, liquid and tradeable. It has low constituent turnover enabling derivative products such as futures contracts and exchange-traded funds to be based on them.
A market indicator index measures either the performance of the overall market or the performance of a select group of stocks that indicate the performance of the overall market.
The Dow Jones Industrial Average reflects the performance of only 30 stocks but is often seen as a convenient barometer of the market as a whole.
A price index measures the capital gains or losses that occur from investing in an index portfolio.
The accumulation index, which is sometimes known as a total return index, takes into account both price movements and income payments relating to the companies in the index.
Calculation of the accumulation index assumes that the value of a company's dividend is re-invested across the whole index portfolio. Accumulation indices serve as the basis for which fund managers benchmark their performance.
