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Stock Indexes; What's in a Name?

September 1, 2021 | Commentary

  • 50 years ago, there were a small number of stock indexes calculated and disseminated to give investors regular updates on what the market overall was doing.  For decades these were usually price weighted averages like the Dow Jones and the Nikkei that could deviate meaningfully from the total market on any given day.
  • With advances in finance theory, urging investors to “own the market,” capitalization weighted stock indexes like the S&P 500 moved to the forefront, though there continues to be a large population that follows the Dow every day.
  • Today there are thousands of indexes calculated in real time by scores of providers, each claiming to be a superior representation of the country, cap size, sector or a style.  The cause of this proliferation is pure economics.  Indexes are cheap to create and calculate but if they get a following among index funds or ETF’s the royalty revenue streams can be quite large.
  • In reality, there are very few differences for the average investor in the long run across indexes in the same category.  There may be variations from day to day, but across quarters and years these melt away.  Like generic versus branded aspirin, some people may prefer to pay a premium for a name brand index product, but the difference in performance will most likely reflect any difference in costs.
  • It is convenient to think in index terms.  Each day there is a simple numeric metric calculated and communicated.  But investors should never lose sight that it is an asset allocation to U.S. large cap stocks or to all cap international stocks that is going to affect portfolio performance, and not the label put on the benchmark.

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