Close-up: Market Indexes

Physician's Money Digest, June 2007, Volume 14, Issue 6

n.

Market Indexes: Described as market indicators or benchmarks, theyare used to track the performance of a compilation of stocks. Examplesinclude the Dow Jones Industrial Average (Dow) and Standard & Poor's500 (S&P 500).

How many times have you read about the importanceof doing your homework when makinginvestment decisions? By now you've probablylost track of how often you've received this advice. But, it'ssound advice. And one method for doing that homeworkis to utilize tools like major market indexes.

According to the Web site StreetAuthority.com, thesemarket indexes are designed to help investors "measure theoverall performance of the broad stock market." Diligentinvestors use the indexes to compare current market performancewith history. In effect, these indexes can serve asbenchmarks for evaluating your own investment portfolios.

The Old Guard

The Dow is perhaps the best known of all the indexes,at least by name. It's also the oldest, having made its firstappearance on May 26, 1896. And, it contains some of thelargest and most widely held public companies in theUnited States, most of which are household names likeAmerican Express, Home Depot, and General Motors.

The Dow was created by Dow Jones & Company as atool for measuring the performance of the industrial componentof America's stock markets. It is comprised of only30 stocks, which has opened the Dow to some criticism,since it is regularly used as an indicator of overall marketperformance despite its limited scope. Because many ofthe 30 companies open at different times in the morning,using the Dow's posted opening price as a condition of theoverall market could be misleading.

One of the more commonly referenced benchmarks isthe S&P 500, an index of the stocks of 500 large cap companies,most of which are American in origin. Its popularitycould be traced to its transition several years ago froma market-value weighted index to one that is float weighted.In other words, the index is not disproportionatelyimpacted by price movement of companies with greatermarket valuation. Instead, only shares that S&P's determinesare available for public trading are counted.

The New Regime

The Russell indexes are a set of stock indexes that consistof the Russell 3000, which is the main index, and twosubindexes—the Russell 2000 and the Russell 1000. Allthree indexes were created in 1984 by the Frank RussellCompany as objective benchmarks for evaluating managerperformance. And each index has a related but differentfocus.

The 3000 Index, according to StreetAuthority.com, iscomprised of the 3000 largest and most liquid stocksbased and traded in the United States. It attempts to capturethe return of the overall stock market. In contrast, the2000 Index is considered the benchmark for small capstocks, while the 1000 Index tracks the performance ofmost major large cap stocks.

It should be noted, however, that these indexes arerebalanced once annually in June. So, if one companymerges with another or has its stock removed from one ofthe indexes, there could actually be fewer than 3000 stocksin the overall Russell 3000 at various times during the year.

The Wilshire 5000 Index was created in 1974 byWilshire Associates and, because of its size, is often consideredthe total market index. It is designed to track thevalue of the entire stock market, and currently it containsclose to 6700 stocks. It was renamed the Dow JonesWilshire 5000 in 2004 when Dow Jones & Company tookover responsibility for maintaining the index.

To achieve a correlation between an index and one'spersonal portfolio, physician-investors should considerindex funds, which replicate the performance of variousindexes. For example, there are index funds that mirror theS&P 500 and the Wilshire 5000. Many of these index fundsare passively managed in that they operate with little orno human input, which translates into minimal managementfees.

International Market Indexes

Most advisors agree that a well-roundedinvestment strategy should include some exposureto international stocks. With that in mind, the followingare some international market indexes thatcan be used as benchmarks:

•London: The Financial Times 100 Index(FTSE). It's the most widely used benchmark ofequities traded on the London Stock Exchange.

•Brazil: The Bovespa Index. This indextracks the performance of a wide range of stockstraded on the São Paulo Exchange.

•Germany: The DAX Index. This index isused for measuring returns posted by stocks onthe Frankfurt Stock Exchange.

•Hong Kong: The Hang Seng Index. It isthe leading indicator of shares traded on the HongKong Stock Exchange.

Straits Times

•Singapore: The Straits Times Index. Compiledby the newspaper, this index isconsidered Singapore's premier equity index.

•South Korea: KOSPI Index. An acronymfor Korean Composite Stock Price Index, it is anindex of all companies traded on the Korean StockExchange.

POP QUIZ

1) The Dow Jones Industrial Average (Dow) wasfounded in what year?

  1. 1896
  2. 1986
  3. 1689
  4. 1869

2) How many companies make up the Dow?

  1. 10
  2. 20
  3. 30
  4. 40

3) The Standard & Poor's 500 (S&P 500) is an index ofcompanies of what size?

  1. small cap
  2. mid cap
  3. large cap
  4. hybrids

4) Approximately how manystocks are represented todayin the Wilshire 5000 Index?

  1. 5000
  2. 6700
  3. 7500
  4. 10,000

5) How many subindexes are there in the Russell 3000Index?

  1. One
  2. Two
  3. Three
  4. None

Answers: 1) a; 2) c; 3) c; 4) b; 5) b.