The Stock Index & How History Can Make You A Smarter Investor

Smarter InvestorBy Rob Wiegland, Staff Writer

Charles Henry Dow created the first Stock Index in 1884 as a way of averaged the closing prices of 11 stocks considered to be the backbone of the American Economy. Mr. Dow later founded The Wall Street Journal which became the standard in business news reporting. The original 11 stocks Dow selected and averaged became what we now know as the Dow Jones Industrial Average. (DJIA). Today the average contains 30 stocks as a representation of our American Industrial sector.

The basis behind any Stock Index is an imaginary portfolio of stocks placed together to measure a specific area of business or in fact the overall economy of the United States or other foreign nation. Depending on its makeup, a stock index can give investors basic information about the market as a whole or even a certain sector of the market such as for example agriculture.

There is no specific formula for how an index may calculate the stocks in its portfolio nor even as to how each may be “weighted” differently than another. The real purpose is to provide a guideline to the interested party as to the performance of those stocks or sectors of our economy.

The only commonality between different Indexes is that the stocks in their imaginary portfolios are all publically traded stocks.

Here are some examples of the major Stock Indexes (Indices)

The Dow Jones Industrial Average

The Dow is an index of widely held large company stocks that is an indicator of the performance of U.S. industrial sector. The stocks in the portfolio will change occasionally to better represent the “industrial” overview of our American Industrial output. The 30 stocks have included American Express, Boeing, Coca-Cola, General Electric, Hewlett-Packard, IBM, Intel, Johnson & Johnson, McDonald’s, Microsoft, Procter & Gamble, Walt Disney, and Wal-Mart. The index makeup will change as the overall performance of our national industries changes.

Standard and Poor’s Stock Index 500

The Standard & Poor’s Stock Index 500 is an index of 500 of the most widely held stocks from all sectors of our economy. These stocks are not all large companies but small. medium and large cap companies combined into one index. The guidelines for their selection include their market size, liquidity, and the industry sector they represent.

Nasdaq Composite Index

The National Association of Securities Dealers Automated Quotation system, or NASDAQ, represents all domestic and non-U.S. based common stocks traded on The NASDAQ Stock Market. The total stocks it represents is over 3,5000 companies which makes it the largest index by company in the world. The NASDAQ Stock Exchange was established in 1971 as the world’s first electronic stock market and which it still remains.

Wilshire 5000 Stock Index

The Wilshire 5000 Total Market Index is the broadest index available. The idea was to accumulate an imaginary portfolio of a broader representation of the overall economy by listing 5,000 American Companies. That number has been expanded to over 7,000 companies and is a very broad overview of the American Economy.

Russell 2000 Small Cap Index

Since 1972 the Russell 2000 Index has gauged the performance of 2,000 “small cap” stocks which are not usually included in other Indices. The Russell 2000 is the standard benchmark for small-cap U.S. stocks and is helpful useful for tracking small companies with growth potential.

By using stock market “indices” as past history it can become helpful in assessing the historical performance of investment portfolios over time which can give an indication of sector movement.. Know the past performance can allow for a reasonable estimate of stock market cycles. It is important to remember that the past is the past and there is never any guarantee of how stocks will respond in the future.