When several financial assets like stocks, commodities, currencies, bonds and other securities are organised and grouped together based on certain criteria, this is called a “portfolio”. Such criteria may be a certain market (e.g. technology), a market segment (e.g. financial technology) or an asset class (e.g. stocks). Investors may also refer to all their combined assets as their “portfolio” - so generally, the term indicates a collection of securities.
To evaluate economic developments and trends for their strategy, investors need convenient tools to track the market performance of select companies and their issued securities. In certain cases, it would be much too time-consuming to analyse the underlying factors of every single publicly listed company in a market or market segment. That’s where indices come in.
What is an index?
An index is a measure to indicate a change in the size of values such as the price of securities over time. When you hear on the news that stock market prices are going up or down, this trend does not refer to a single stock. Rather, the trend refers to a measurement of a hypothetical portfolio - an index - that represents one segment of the financial markets.
The value of an index is calculated or “weighted” based on the prices of its securities or many other factors, such as market capitalisation (market cap). Investors use market indices as a tool to assess developments such as market movements and much more.
How is an index used?
As an investor, you want to watch the performance of indices that are relevant to the assets you are invested in. Tracking an index may provide you with valuable information of how your portfolio is performing, as indices provide a benchmark to compare your portfolio to.
Investors can’t invest directly in an index as it is a hypothetical basket of securities. They invest in index funds such as ETFs or mutual funds mimicking an index. Exchange-traded funds (ETFs) track a certain index and directly replicate its performance, meaning the fund will develop like the index, either in an advantageous or disadvantageous way.
