What an index is, and what it is not

Before we look at each index specifically, it helps to clarify one important point.

An index is not something you can buy directly.

An index is simply a number. It is a calculated figure that represents the combined performance of a defined group of stocks, weighted in a particular way. In simple terms, it functions like a weighted average. The index tells you whether that particular group of companies, taken together, moved up or down over a given period.

The reason this distinction matters is that investors do not invest in the index itself. The index is only a benchmark or measuring tool.

What investors actually buy are investment products that are designed to track the index.

These usually take the form of:

• Exchange Traded Funds (ETFs)
• Index mutual funds

Such funds attempt to replicate the composition of the index by holding the same companies in roughly the same proportions as specified by the index methodology. Because the fund owns the underlying stocks, its performance tends to closely follow the index.

This is why people often say things like, “I invested in the S&P 500.” In practice, what they mean is that they purchased a fund that tracks the S&P 500.

The index itself remains only the reference point.

And this is where the subject becomes more interesting.

Different indices are constructed using different methodologies. The companies included, the weights assigned to them, and the rules governing the index can vary. As a result, different indices can present slightly different pictures of the same market depending on how they are designed.