Stock market indices

Discover what a stock market index is, how they are constructed, and how you can invest in stock market indices.

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From the UK’s FTSE 100 to the US’s Dow Jones, chances are that even those new to investing will have come across some of the world’s leading stock market indices. We’ve explained how they work and summarized the key stock market indices in the UK and globally.

What is a stock market index?

Stock market indices are effectively virtual portfolios of pre-selected stocks that allow investors to get a sense of how an economy, or a subset of that economy, is performing. An index acts as a barometer of the state of a market and enables investors to track the ups and downs of the selection of stocks within it. An index can contain anything from less than 50 to several thousand stocks.

What are the different types of stock market index?

There are a few types of stock index. Some of the mains ones are:

  • Stock indices based on the size of companies listed on a given stock exchange (or stock exchanges). Size is often measured by market capitalisation (often abbreviated to market cap). This is the amount you would pay to buy all the company’s shares on the stock exchange. For example, the FTSE 100 is an index of the biggest 100 stocks on the London Stock Exchange by market cap, while the FTSE 250 tracks the next biggest 250.
  • Stock indices that track certain sectors or types of stock. So you might come across indices that include only technology stocks, such as the Dow Jones US Technology Index, or ones that include only “growth” stocks, such as the S&P 500 Growth Index.

The same stock can feature in more than one index. And some indices track stocks across more than one stock exchange. The Dow Jones, for example, includes stocks listed on both the New York Stock Exchange (NYSE) and the Nasdaq.

How are stock market indices weighted?

Almost as important as the stocks that make up an index is the impact each stock can have on the index’s performance – known as weighting. Some of the main weighting methods are:

  • Equal-weighting. All companies listed will have the same impact on the index’s performance, regardless of size, market cap or share price.
  • Market-cap weighting. Here, bigger companies by market cap will have a bigger impact on the index’s performance. For example, the S&P 500 is market-cap weighted. This means that behemoths such as Microsoft impact the index’s overall performance far more than smaller companies.
  • Price-weighting. Price-weighted indices give more weight to companies with a higher share price, regardless of their actual size.

What are the main stock market indices?

There are 60 stock exchanges worldwide and millions of stock indices, so listing them all here would make for a pretty long article (we suspect we might test the word limit for our website). But we’ve rounded up the main UK and international stock indices you will likely encounter.

Main UK stock market indices

There are around 20 stock indices based on the London Stock Exchange, including the main market and the AIM market, home to small and medium-sized growth companies. Key indices include:

  • The FTSE 100 index. This includes the 100 largest companies on the London Stock Exchange by market cap. These are typically well-established companies with a proven track record – think Aviva, NatWest and Sainsbury’s.
  • The FTSE 250 index. This monitors the companies in positions 101-350 on the London Stock Exchange. It tends to include a lot of medium-sized rather than very large companies. For example, ASOS, Domino’s Pizza and Dunelm. Put together, the FTSE 100 and FTSE 250 comprise a third index – the FTSE 350.
  • The FTSE All-Share index. This represents 98-99% of UK stocks by market capitalisation. It includes all the companies in the FTSE 100 and FTSE 250, plus those on the dedicated ‘Small Cap’ index, which comprises companies on the LSE Main Market that fall outside the FTSE 100 and 250.
  • The FTSE AIM 100 index. This incorporates the largest 100 companies that have their primary listing on the AIM market. These include the likes of Hotel Chocolat, Boohoo and Fever-Tree.

Main US stock market indices

  • The Dow Jones Industrial Average index. Often shortened to just “Dow Jones”, this is one of the world’s oldest stock indexes. It is made up of just 30 stocks – the most-traded on the New York Stock Exchange and the Nasdaq. Companies include American Express, Apple and Disney.
  • The S&P 500 index. The S&P 500 (or Standard and Poor’s 500, to give it its full name) is an index of the 500 largest listed companies in the US. Here you’ll find big US names such as Apple, Amazon, Microsoft and Tesla.
  • The Nasdaq Composite. The Nasdaq stock exchange is well known for its focus on technology companies, and the Nasdaq Composite tracks all 3,000+ stocks that are exclusively listed on this stock exchange, making it a pretty large index. As well as the tech behemoths mentioned above in relation to the S&P 500, you’ll also find the likes of Adobe, Netflix and T-Mobile.

Other leading international stock indices

  • The DAX index. The DAX represents the 30 major companies listed on the Frankfurt Stock Exchange. These include German powerhouses from a wide range of sectors, including Allianz, Siemens and Volkswagen.
  • The Euro Stoxx 50 index. This includes 50 of the biggest companies from across the Eurozone and is often seen as Europe’s leading blue-chip stock index. Companies listed include L’Oreal and Unilever.
  • The Hang Seng index. This comprises around 60 stocks from the Hong Kong Stock Exchange, one of the world’s biggest exchanges. It has 4 sub-indexes: finance, industry, real estate investment trusts and utilities. Well-known names include Alibaba and Lenovo.
  • The Nikkei 225 index. This tracks a selection of 225 domestic common stocks that trade on the primary market of the Tokyo Stock Exchange, one of the 10 biggest stock exchanges in the world by market cap. Japanese technology and car firms feature heavily, such as Sony and Toyota.

How can I invest in a stock market index?

There are a few ways to get exposure to stock market indices.

  1. Buy shares in each company listed in an index. This would be a much bigger task for some indices than others. Buying shares in the 30 stocks of the Dow Jones, for example, might be more achievable than the thousands making up the Nasdaq Composite.
  2. Invest in an index fund. Such funds are collections of stocks designed to reflect the stocks in an index. When you invest in an index fund, you (along with many other investors) purchase a stake in all the companies the fund invests in. When a stock moves in or out of the index, your holdings automatically change, too, without you having to do a thing.
  3. Speculate on the future performance of an index via CFDs or spread betting. Both involve essentially “betting” on the future value of a given market, in this case, an index. This kind of fast-paced, short-term trading can be pretty risky, and many traders lose money, so it’s best suited to very experienced investors who really know what they’re doing and can afford to take the risk.

For all of these types of trading, you’ll need to sign up for a broker or online investment platform to access the stock markets and relevant indices you’re interested in. If you want to buy international stocks, make sure that your chosen provider has access to the relevant stock exchange. Investing in international index funds might be a bit more straightforward, as many providers offer access to a wide range of globally focused funds.

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What affects the performance of a stock market index?

Just as the performance of an individual stock can be affected by a wide range of factors, so too can the performance of a stock market index. Key movers and shakers can include:

  • Company announcements. If a company whose market cap makes up a significant chunk of an index makes a big announcement, even changes to a single company can impact an index – especially a fairly small one. This could be a change of leadership or a merger, for example.
  • Company financial results. If a major company’s financial reports reveal higher- or lower-than-expected profits or losses, this too can affect an index.
  • Changes to the companies included in an index. Fairly obviously, if a less highly valued company is swapped on for a more highly valued one, this affects the index’s overall value.
  • Prices of commodities. If many companies that make up an index rely on commodities – the raw materials used to create consumer products, such as wheat, natural gas or metals – any fluctuations in the commodity market could impact the index’s performance.
  • The wider economy. As well as changes that affect individual companies, wider national or global events can affect entire sectors or even economies. These include political unrest, central bank announcements, natural disasters or pandemics. The coronavirus pandemic, for example, saw tech-focused indices thrive during lockdowns. Many are subsequently taking a dip as life returns to normal and people rely less on tech for communication and entertainment.

What are the pros and cons of index investing?

Let’s assume that by index investing, you’re looking to replicate – as closely as possible – the performance (and returns) of the index you’re investing in. For example, by investing in a fund that tracks the index. This approach, also often known as “passive investing”, has pros and cons.

Pros of index investing

One of the advantages of passive investing is that, because index funds simply replicate a pre-determined set of stocks, there’s relatively little work for the fund manager to do. This typically makes for lower fees than on actively managed funds. Assuming equal performance, lower fees equal better overall returns for investors.

And in fact, evidence suggests that funds that passively track indices tend to beat actively managed funds over time, so they are a good choice for many investors to include in their portfolios.

Cons of index investing

The main downside of index investing is that, although passive funds may typically do better than active ones, as there’s no chance of the fund manager making any major mistakes, there’s also no chance of the fund manager getting it spectacularly right and beating the market.

Some investors may also argue that investing completely in line with an index is too restrictive on the assets they can include in their portfolio.

Is it better to invest directly in index stocks or in an index fund?

Danny Butler

Finder insurance expert Danny Butler answers

It’s not really a case of which is better, so much as which is more straightforward and suited to different investors.

Investing in a fund is the simpler and more straightforward option. With a single transaction, you can get exposure to every single stock featured in an index. You’re effectively already investing in a portfolio of sorts, which automatically spreads your risk. Fees are likely to be lower, plus you don’t risk having to cough up the dough to buy a full share in every company in an index, which could be out of some people’s price ranges. Investing in funds is often a good choice for less experienced investors.

In contrast, it’s fair to say that buying shares in all the companies that make up even a relatively small index, such as the FTSE 100, would be fairly labour-intensive. And if you wanted to mimic it precisely, you’d need to be willing to devote time and effort to keeping up with changes to an index as the companies on it change over time. And to pay a hefty whack in transaction fees for buying and selling shares. On the plus side, it’s a more flexible approach. If you didn’t want to invest in some of the companies in an index, you could simply exclude them from your purchases or swap in others that fit better with your investment preferences. This approach might be preferable for some more experienced investors.

Bottom line

Stock market indices can be a valuable tool for investors to gauge the state of an economy or sub-sector. Meanwhile, index funds can be a good entry point to investing for beginners, allowing them to get exposure to a fuller portfolio of stocks than they might be able to by investing directly in stocks. They can also be a less risky option for more experienced investors to include in their portfolios, and investing in international stock indices can make for a more balanced portfolio than sticking with UK investments alone. Head over to our full guide on how to invest in index funds to get started.

Frequently asked questions

All investing should be regarded as longer term. The value of your investments can go up and down, and you may get back less than you invest. Past performance is no guarantee of future results. If you’re not sure which investments are right for you, please seek out a financial adviser. Capital at risk.

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