When you want to know what the stock market is doing, you could scroll through hundreds of numbers of individual stocks and try to figure it out.
Or you could look at just one number: a stock market index.
A market index can give you a snapshot of how a segment of the broader market is doing. For example, the Standard & Poor's 500, commonly called the S&P 500, tracks the stocks of 500 large American companies. When these companies' stocks move in one general direction, the index will shift as well.
You can use various market indexes to get a sense of how your investment portfolio (such as your 401(k)) is performing compared to the rest of the market or how investors are feeling (optimistic? pessimistic?) about the economy or certain sectors of the economy. (See below.)
There are literally thousands of indexes, which cover everything from Asian real estate to United States technology. But there are three, taken together, that will tell you how the world economy is doing as a whole: The S&P 500 in the United States, the FTSE in the U.K., and the Hang Seng in Hong Kong. You can look at these three numbers, and if you don't read any other investing news, you can say with confidence how the global market did today.
The S&P 500
Considered a bellweather for the American economy and stock market, the S&P 500 is the index that you will hear about the most. It's made up of 500, mostly U.S.-based, large-cap corporations (meaning they are worth at least $5 billion). The companies are chosen by a committee at Standard & Poor's so that they broadly represent the main industries of the U.S. economy; it includes familiar names like Amazon, Exxon and Macy's. The value of the S&P 500 is updated every 15 seconds during the workday.
The FTSE, which you'll hear called "the footsie", is a joint venture of the Financial Times and the London Stock Exchange that compiles a variety of indexes. Its most well-known index is the FTSE 100, which is made up of the 100 largest U.K. companies listed on the London Stock Exchange. Some companies you might have heard of in this index include BP, Unilever and Burberry. The FTSE 100's performance usually reflects Europe's economic climate and is relevant for you if you hold any European-based stocks or mutual funds.
The Hang Seng
The Hang Seng is made up of the 45 largest companies in the Hong Kong stock exchange in China, and is maintained by a subsidiary of the Hang Seng Bank. The Hang Seng is used by analysts and investors in conjunction with the FTSE and the S&P 500 to gauge the health of the world economy. Some companies you may recognize in this index include HSBC, Esprit and Foxconn International.
Why We Use Indexes
Indexes are valuable in three ways: Depending on what an index includes, it can give you a quick picture of economic performance in various regions around the world or within a particular industry. If the S&P 500 is going gangbusters, you can be almost sure that the U.S. economy is, too. Similarly, when an index tracking technology companies drops, it's likely the industry is in a slump.
Secondly, indexes can help you gauge the performance of your own portfolio, depending on your investments. For instance, if you have investments in a broad swath of U.S. companies and the S&P is climbing, it's a safe bet that your portfolio—including everything from your stocks to your 401(k)—is also gaining value.
Third, indexes provide a simple way to hedge your risk and invest in a large number of companies without buying individual stocks. While you may not have the time, money or knowledge to research and purchase 500 different stocks, you can easily invest in an index fund or ETF that mimics the performance of an index and the market or industry as a whole. (For more on funds, read this.)
Quick, easy investments that lower your risk? We say, sign us up.