"The stock market was up 37 points yesterday." Statements like that make the market seem like a single entity, as if all stocks rose together, and presto, a gain of 37 points resulted. In reality, stocks rarely move together like that—on any given day, thousands increase in value while thousands of others decline in value. Any statement you hear about how "the market" did has everything to do with which particular group of stocks is being measured.
A stock index attempts to measure changes in value of a specific group of stocks. There are many different stock indexes, with each measuring how a different type of stock is performing. For example, there are indexes that measure the performance of small company stocks, and other indexes that focus exclusively on large company stocks. Indexes serve as benchmarks against which you can evaluate the investment performance of the stocks or mutual funds you own. But just as learning what yesterday's weather was like in Atlanta won't tell you if it rained in Denver, so it is with stock market indexes. Knowing how the largest stocks performed is of little value if you own a mutual fund that invests in small companies. You have to select the correct index to get meaningful information, and that means finding one that is similar in content to your portfolio. Here's a brief review.
Indexes that Measure the Whole Market
When trying to measure the performance of the stock market as a whole, it's important to choose an index that includes as many stocks as possible. There are indexes that fill this specific need.
• Wilshire 5000. This is the broadest of all the market indexes. If you had to pick one index that most closely represents the behavior of the entire U.S. stock market, this would be the one. That's why we use this index as the benchmark for evaluating the performance of SMI's model portfolios. Its name reflects the fact that when it was created over thirty years ago it covered roughly 5,000 stocks. It has grown to cover many more today, and represents the performance of 99-100% of the market. Like most stock indexes, it is "market-value weighted." This means that the price change of a company whose total shares are worth billions of dollars will have much more of an impact on the index than the price change of a smaller company whose total shares are only worth several million dollars.
• Russell 3000. Launched in 1987 by the Frank Russell Company, this index is similar to the Wilshire 5000 in that it covers roughly 98% of the entire market. The Russell indexes are newer stock indexes, and have become increasingly popular due to their ability to offer more precise breakdowns between different kinds of stocks. If it seems odd that multiple indexes exist to measure the same thing, understand that the companies that create and track these indexes are competitors, each trying to produce the more popular "product line" of indexes to follow.
Large Company Indexes
The companies that comprise the "large-capitalization" (or "large cap") indexes are often referred to as "blue chip stocks," and include many corporate household names.
• Dow Jones Industrial Average (DJIA). Perhaps the best known of all market indexes, it is also perhaps the least useful major index now that so many alternatives are available. A significant problem is that it only measures the performance of thirty specific companies. While they are selected carefully to reflect the fortunes of the general economy, it's an impossible task to expect a sampling of 30 stocks to do this as well as samples of 500, 1000, or more. The fact that the Dow is price-weighted, meaning higher priced stocks have more influence than lower priced ones, also hinders its usefulness.
