Index: meaning, history, and facts

Glossary

What is an index?

An index, or stock index, is a tool that shows how the weighted average of a basket of company stocks within a specific stock exchange or sector is performing over a particular period. Besides stocks, this basket can consist of other investment products such as bonds, commodities, or something else. 

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What is another word for index?

An index is often also called a ‘stock index’, ‘stock market index’, ‘market index’ or, in plural, ‘indices’. In the financial world, people use these words interchangeably, but they mean the same thing: a way to measure and track the performance of a group of investments

The history of stock market indices

One of the most famous and first stock market indices was created in 1896: the Dow Jones Industrial Average (DJIA) in the United States. The name is a combination of the names Charles Dow and Edward Jones, although the latter did not play an active role. The goal was to provide a snapshot of American industry, so investors could easily see the state of the stock market and the economy.

More than half a century later, other indices were founded. The well-known S&P 500 followed in 1957, the Nasdaq Composite in 1971, and the AEX in 1983. These indices grew into important benchmarks for economic health and market returns.

What is the purpose of an index?

The main purpose of an index is to see how the market performance of a specific exchange or sector is moving (indicator). If the index goes up, it means the companies in that index are generally doing well and investors are feeling positive. But an index has even more purposes:

• Comparing: As an investor, you can see how well your investment performance is doing relative to the market.
• Risk insight: You gain insight into the general risk level and volatility of a market.
• Investment products: An index is the basis for index funds, ETFs, options, and futures.

Well-known indices

Worldwide, there are various indices that track companies from a specific country or area. In the Netherlands, this is the Amsterdam Exchange Index (AEX). This index tracks the 25 largest listed companies in the Netherlands (large cap). Medium-sized companies are part of the Amsterdam Midkap Index (AMX Index), and small companies belong to the Amsterdam Small Cap Index (AScX Index).

Other well-known indices are the DJIA, S&P 500, Nasdaq, and MSCI World. There are also specific indices for sectors like technology or sustainable energy.

The composition of an index

An index is composed of various companies. The selection and number of these companies vary per index. For example, the AEX tracks the 25 largest listed companies in the Netherlands, and the Dow Jones Industrial Average tracks 30 in the United States.

Furthermore, the composition is reviewed and adjusted from time to time, for instance, due to bankruptcy, a merger, or a shift in the business model. An adjustment may also be necessary to better reflect current economic sectors.

What is an index number and how is it calculated?

A stock exchange operates with an index number. An index number is the figure that shows how much an index is worth at a specific moment. The number rises or falls depending on how the underlying stocks perform. In most cases, the values of each company within the index are added together and then divided by a specific factor, the ‘weighting’ of the index. Below are a few methods.

Market capitalisation-weighted index (market cap)

In a market capitalisation-weighted index (market cap index), companies with a higher market value carry more weight. This is fair because larger companies have more impact on the market, but the disadvantage is that a few megacompanies can strongly influence the index. The AEX is a market capitalisation-weighted index.

Price-weighted index

In a price-weighted index, such as the Dow Jones, the price of a stock determines how much influence it has on the index. This means more expensive stocks carry more weight, even if the company is smaller. This can sometimes distort the market view.

Equal-weighted index (equal-weighted)

In an equal-weighted index (equal-weighted), every stock carries equal weight, regardless of size or price. This ensures more diversification, as small and large companies have equal influence. If a large company loses a lot of value, it has less impact on the index. A well-known example is the S&P 500 Equal Weight Index.

Fundamentally weighted index

In a fundamentally weighted index, a company’s financial strength—such as revenue, profit, or dividend—determines how heavily it is weighted. This makes the entire index less dependent on market value or stock price. The better the financial figures, the higher the valuation.

Investing in an index

You cannot invest directly in an index. So-called index investing is done via ETFs or investment funds. Instead of investing in a single company, you invest in dozens or hundreds of companies at once, which ensures a diverse investment portfolio and low transaction costs. You can find more information about this on our page ‘investing in ETFs‘.

You can buy an ETF via a broker, such as BUX. With us, you’ll find a diverse range of ETFs. For example, you can invest in ETF providers like iShares by BlackRock, SPDRs by State Street Investment Management, and VanEck..

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All views, opinions, and analyses in this article should not be read as personal investment advice and individual investors should make their own decisions or seek independent advice. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication.