Editor's note: This is a special excerpt from
Check the BenchmarkJust as it's smart to check prices when you're ready to go shopping, it's smart to compare performance when you're ready to shop for stocks. You can do this by comparing the performance of the stock you're interested in with the performance of the stock's market index. Let's say you went shopping for a pair of hiking boots before you headed into the jungle. You'd be interested in the price of the boots, but you'd be even more interested in how comfortable they were on your feet -- in other words, their performance. A market index compares to the average level of comfort of all hiking boots (or maybe the 15 styles you tried on). If you decide to buy L.L. Bean boots, you might compare the comfort level of L.L. Bean's boot to the comfort level of all the boots you tried on to decide if L.L. Bean is more or less comfortable (meaning, if the boots perform better or worse). Each index is made up of a group of stocks that have some shared characteristics. So if you're considering a particular stock (or boot), you compare its performance to the average performance of its index (the group of 15 boots you tried on). Make sense? Market indices are also called
- Company size
- Stock liquidity
- Industry ranking
An index's defining characteristic, or characteristics, causes benchmarks to vary according to the characteristics of the stocks that comprise it. Let's take a closer look at each of the indices. Define Your Index The S&P 500 Index: If you're interested in buying stock from a "large-cap" company, meaning companies with the most money circulating in the stock market ($5 billion or more), this is the index you compare it to. This index, the most widely known, and widely regarded, benchmark of the U.S. equities market, compares the performance of a representative sample of 500 "large-cap" companies in leading industries of the U.S. economy. The S&P 500 is maintained by the S&P Index Committee, whose members include economists and analysts. The committee rates stocks based on how big they are, how liquid, or available their assets are, their rank in their industry, and how diversified they are. The S&P 500 is frequently used as the standard of comparison in determining a stock's investment performance. The DJIA, or Dow Jones Industrial Average. If you want to buy one of the "blue-chip" stocks, which are known for their ability to make money and pay dividends to shareholders, then this is the index to compare it to. This index measures 30 "blue-chip" stocks, which get their fancy name from the companies they represent. These are large, creditworthy companies traded in the U.S., which are famous for their quality and the wide acceptance of their products and services. By studying these companies, many believe you can get a good picture of how the market as a whole is performing. This index, prepared and published by Dow Jones & Co., is one of the oldest of all the market indicators. The companies within the Dow are widely held by individuals and institutional investors. The Dow's 30 stocks represent about a fifth of the $8 trillion-plus market value of all U.S. stocks, and about a quarter of the value of stocks listed on the New York Stock Exchange. Although there are now dozens of alternatives, the Dow is still the index financial professionals instinctively check first to see how "the market" is doing. It has a wide following among investors and is well known by even those who don't invest. NASDAQ Composite Index. If you're looking for an index that contains companies whose common characteristic is size, or "market capitalization," measured according to the total dollar value of all outstanding shares, check out this index. The NASDAQ Composite Index looks at the market capitalization of both domestic and international stocks. Because it is so broad-based, and evaluates more companies (over 4,000) than most other stock market indices, the NASDAQ is also widely followed and quoted among the major market indices. Russell 3000 Index. If you're looking at a stock from a new and growing company, this is the index to compare it to. The Russell 3000, which represents 98% of the U.S. market, provides a barometer of the broad market and is revised annually to include new and growing equities. Russell 2000 Index. If you're looking at stock from a "small-cap" company (a company with less than $1 billion in the stock market), this is the index to compare it to. The Russell 2000, which includes the smallest 2000 securities in the Russell 3000, offers investors access to "small-cap" companies. Like the Russell 3000, this index is also revised annually. The Dow Jones Wilshire 5000 Index. This index, the largest of the indices, measures the performance of nearly all U.S. companies. This means you could compare any stock to this index, especially those that don't have any of the characteristics of the above indices.
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|Market Index Characteristics|
|Index||# of Companies||Average Size||Comment|
|S&P 500||500||Large-cap||Widely known index|
|DJIA||30||Large-cap||Includes "blue-chip" stocks from large, creditworthy companies|
|NASDAQ||4,000+||Various||Broad-based, includes domestic and international|
|Russell 3000||3000||Various||New and growing companies|
|Russell 2000||2000||Small-cap||Includes the smallest 2000 securities in the Russell 3000|
|DJ Wilshire 5000||5000||All||Largest and broadest of U.S. stocks|