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There’s a lot of stock market indexes out there (Dow Jones, S&P 500, Nasdaq, the VIX, etc.) and you’ve probably either read about them in the news or heard somebody talk about them at some point. If you’re not sure what a stock market index is and how they work, then you will enjoy this post!

So if you want to learn more about things like:

  • The 9 major stock market indexes all investors need to know about
  • What goes into the calculation of an index
  • And most importantly, how you can use stock market indexes to make money,

Then watch the video below or keep reading!

 

What is a stock market index used for?

Stock market indexes are nothing more than a mathematical average that quickly tells you how the stock market is doing.

I think we overcomplicate things in our mind, especially when it’s related to finance & investing, but I guarantee all of you are already familiar with indexes. For example, if you and 10 of your friends each weighed yourselves and you calculated the average weight of the entire group – that would be an index. And as your weights changed, the index would change too.

Anything that’s a calculated average of many different components, can be considered an index. The S&P 500, which is the most widely used stock market index, is the average of the 500 largest U.S. companies, all rolled up into one easy-to-read average price.

The level of the S&P 500 index is expressed as “points”. The S&P is up 10 points, it’s down 10 points, for example. Most indexes use weighted averages according to market capitalization, which biases the index towards the largest companies.

The real-time calculation of stock market indexes is a complimentary service provided by major financial data companies. The name S&P 500 comes from Standard & Poor’s, the company that officially created the index. And obviously, the 500 comes from the 500 components in the index. Although there’s a lot more than 500 stocks in the U.S. (there’s actually thousands of them!), the S&P 500 is a pretty accurate barometer of how the OVERALL U.S. stock market is doing, because all the largest and most influential companies are part of the S&P 500 index.

In the U.S., when you hear people say “the market is up today”, they’re probably referring to the S&P 500. Not because the S&P 500 IS the market, but because it’s a representative chunk of the market.

Other countries have their own stock market indexes. Japan has the Nikkei 225, Brazil has the Ibovespa, the UK has the FTSE 100, in Germany there’s the DAX, and in Korea they have the KOSPI. Just flip to the back of The Economist magazine, and you’ll find a comprehensive list of all the countries and their stock market indexes.

If you want to know how the economy is doing, you can just look at the stock market index for that country. Stock market growth and economic growth often go hand in hand, and of course the opposite is also true. For example, Venezuela’s economy has been falling apart under the regime of Nicolas Maduro, and it shows in its stock market performance. Venezuela’s stock index the IBVC, went down by 94% last year!

There are 9 major indexes that all investors need to know about.

Following these indexes will keep you informed about the economy and as a result, help you make smarter decisions with your money. Here they are:

  • S&P 500, which we’ve already talked about. Since U.S. corporations are very international and play such a powerful player in global markets, the S&P 500 is the most-followed stock market index in the world.
  • Then there’s the Dow, which is short for Dow Jones Industrial Average and is made up of the 30 largest companies in the U.S. Personally, I think the Dow is a bit redundant because its 30 components are also included in the S&P 500 index.
  • There’s also the NASDAQ, which consists of over 3000 stocks and has a heavy bias towards technology companies.
  • For a more global perspective, the MSCI World Index covers all the major stocks across 23 developed countries, so this is often used as a barometer of the world economy as a whole
  • There’s also the MSCI Emerging Markets Index, which covers the stock markets across 24 emerging market countries, so countries like Brazil, China, and India.
  • There are indexes for everything, not just stock markets. The S&P GSCI Commodity Index tracks commodities like oil, gold, silver, soybeans, corn, cotton, wheat, and even… cattle. So if you want to know how a certain asset class has performed over the last few years, you can just look up the most widely used index for that category.
  • For example, for a quick snapshot of real estate, you can look up the Dow Jones Real Estate Index.
  • The Dollar Index is another super important index that tells you how strong the U.S. Dollar is relative to other major currencies like the Euro, Pound, Japanese Yen, and Canadian Dollar. Back in when DXY was low, the dollar was very weak which mean traveling to Europe was super expensive! Now that the DXY has climbed a lot higher, planning a trip to Europe is a lot easier on your wallet. Who knew financial indexes could be useful for planning your travel adventures!
  • Last but not least, you should also know about the VIX, also known as the “fear index”. The VIX gauges the level of fear present in the stock market by tracking the price levels of options, which are complex financial instruments that are used as insurance against disaster. When the financial crisis happened in 2008, the VIX spiked from 18 to 79, and the S&P 500 dropped 20% in the same day! So whenever something scary or really unexpected happens, the VIX jumps. It’s useful to watch the VIX to understand market sentiment.

Now let’s talk about how you can use stock market indexes to make money!

As great as they are, you can’t actually invest in the S&P 500 index or in any of the other indexes we’ve talked about. That’s because an index is just a mathematical average published by a financial data company. So although you can’t invest in an index, you CAN invest in an index FUND.

An index fund is an investment vehicle that mirrors an index.

For example, you can invest in an S&P 500 index fund – such as the Fidelity 500 Index Fund or the Vanguard 500 Index Fund. This would immediately make you a part owner of all 500 companies in the index.

If the S&P 500 index goes up 5%, your investment in the index fund also goes up 5%.

If the S&P 500 goes down 5%, your investment also goes down 5%.

If you don’t know how to pick stocks, this is a good way to get started. Investing in index funds is a convenient way to basically own a piece of the entire economy, because an S&P 500 index fund will have stocks in retail, financial services, construction, technology, healthcare, and a whole bunch of other industries.

Always remember to go after your dreams unapologetically, and to live life on your terms – cheers!

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YouTuber, Money Expert, Educator, Traveler, Rebel, and #1 Book Nerd. My mission is to empower you with the mindset and financial know-how to create a life of TOTAL freedom.

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Rose

YouTuber, Money Expert, Educator, Traveler, Rebel, and #1 Book Nerd. My mission is to empower you with the mindset and financial know-how to get more of what you want out of life.

The weekly email that spills all the secrets on what it really takes to create a life of total financial freedom

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