Too embarrassed to ask: what is an index?
The FTSE 100 is probably the best-known stockmarket index in the UK. But what exactly is an index?
Even if you couldn’t care less about investing, you’ve probably heard of the FTSE 100. The FTSE 100 is the best-known stockmarket index in the UK. In effect, it sums up the fortunes of Britain’s biggest listed companies into one single number, by combining them all into one hypothetical portfolio.
Why is this useful? It gives a representative snapshot of how strong or weak the market in big UK companies is at any given point in time. But more importantly, it serves as a useful benchmark.
If you invest with a fund manager who says they will put your money into big UK companies, then how do you know if they are doing a good job or not? One way to tell would be to compare their performance to that of the FTSE 100. If they manage to beat the index over the long run, it suggests that their stockpicking skills are adding some value for you. If not, then why pay them to manage your money?
Subscribe to MoneyWeek
Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE
Sign up to Money Morning
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
There are many different ways to construct an index. Most indexes, including the FTSE 100, are based on market capitalisation – that is, the share price of each company multiplied by the number of shares outstanding. In other words, the companies deemed most valuable by investors carry the most weight in the index.
The best-known indexes tend to be the ones that represent individual countries’ stock markets. Other indexes you may well have heard of include the Dow Jones or the S&P 500 in the US, and the Nikkei in Japan. However, there are literally thousands of different indexes available, and there are many different ways to build them.
As passive investing – which aims to track an index, rather than beat it – has boomed in popularity, index providers have become huge businesses. As investor demand for index funds that track specific themes, or specific investment styles has grown, index providers have created custom indexes to back these investment products.
Some fear that the boom in indexing may distort the flows of money into financial markets in disruptive ways. However, there is no doubt that index funds can be a very convenient and cheap way to build a diversified long-term investment portfolio.
To learn more about index investing, subscribe to MoneyWeek magazine.
-
Hargreaves Lansdown bumps up cash ISA with £25 cashback - does it beat the wider ISA market?
Just days before the end of the tax year, Hargreaves Lansdown has launched a £25 bonus for those who open a cash ISA on its savings platform. Does the bonus make it a competitive rate, and are you eligible for the cashback?
By Vaishali Varu Published
-
FCA targets finfluencers with new social media guidance
So-called finfluencers have been warned by the UK financial watchdog that they could face prosecution if they fail to follow new rules.
By Henry Sandercock Published
-
What is an investment trust?
Videos “Active” investment funds come in two main varieties, one of which is investment trusts. But what exactly is an investment trust?
By Rupert Hargreaves Last updated
-
What is a dividend yield?
Videos Learn what a dividend yield is and what it can tell investors about a company's plans to return profits to its investors.
By Rupert Hargreaves Published
-
High earners to pay nearly £2000 more in tax due to fiscal drag
Videos The government froze tax thresholds, which will drag employees into higher tax bands as wages rise with inflation. We explain what fiscal drag is, and how to avoid it.
By Nicole García Mérida Last updated
-
What is a deficit?
Videos When we talk about government spending and the public finances, we often hear the word ‘deficit’ being used. But what is a deficit, and why does it matter?
By moneyweek Published
-
Too embarrassed to ask: what is moral hazard?
Videos The term “moral hazard” comes from the insurance industry in the 18th century. But what does it mean today?
By moneyweek Published
-
Too embarrassed to ask: what is contagion?
Videos Most of us probably know what “contagion” is in a biological sense. But it also crops up in financial markets. Here's what it means.
By moneyweek Published
-
Too embarrassed to ask: what is a marginal tax rate?
Videos Your marginal tax rate is simply the tax rate you pay on each extra pound of income you earn. Here's how that works.
By moneyweek Published
-
Too embarrassed to ask: what is stagflation?
Videos Traditionally, economists and central bankers worry about inflation or recession. But there is one thing worse than both: stagflation. Here's what it is
By moneyweek Published