What are stock indices and how to use them

2024 Author: Malcolm Clapton | [email protected]. Last modified: 2023-12-17 03:44

These tools are useful for both beginners and professionals.

What is a stock index

It is a financial indicator that tracks the value of a group of securities, grouped according to a specific criterion: country, industry or asset class. For example, there is an index of shares of the largest Russian companies on the Moscow Exchange or an index of US Treasury bonds.

You cannot buy a stock index directly. This is not a security, but just a mathematical indicator. But on its basis, you can invest and analyze the stock market.

Financiers came up with indices because it is impossible to track changes in the prices of thousands of securities. But if you collect some of them into a special tool, you will be able to understand market sentiment or assess how good an investment portfolio is.

Let's say an investor earned 10% per annum on Russian municipal bonds for 2020. And this is an excellent result, because the Mosbirzh index for the same period showed a yield of 5, 5-6, 5%: the investor performed better than the market. But if the index rose by 20%, then 10% would no longer boast.

Indices are made up of special divisions of financial firms or entire companies. It is too difficult for a private investor to calculate information on his own, and it is not even necessary: almost all stock exchanges have such indicators, plus the largest rating companies like Standard & Poor's, Dow Jones, MSCI or Expert RA.

How does a stock index work and why is it needed

Indices are calculated by professionals, therefore they are based on complex calculations, formulas and mathematical models. They are processed and the result is published - the value in special units, points.

For example, one of the oldest indices in the world, the Dow Jones Industrial Average, monitors the 30 largest blue chips in the US stock market. The methodology is 17 pages long, but in a nutshell: it is a price-weighted index that is calculated by adding up the value of stocks and then dividing them.

In 1884, the Dow Jones Industrial Average was 28.46 points. After 136 years, the index reached the level of 30 606, 48. This means that the dollar invested then would have multiplied more than a thousand times.

Another popular index, the S&P 500, is calculated differently. It includes 500 American companies with the largest capitalization, for whose financial indicators even more complex formulas are derived.

Investors use the Dow Jones, S&P 500 and many more indices to value their investments. Perhaps the portfolio brings in as much as the market as a whole. Maybe the investor's results are even better and he is great. But the index will also tell you what needs to be changed.

• Sell bad assets. Portfolio return is below market - an investor can analyze his assets and understand that the shares of several companies are pulling down the overall result. Perhaps they should be eliminated in order for profitability to rise.
• Buy promising assets. It may be the other way around: the investor has a good portfolio and it is even worth increasing the share of profitable investments. Or buy shares of interesting companies that can bring more money.
• Improve diversification. Securities are a market instrument, so their value is volatile. But if the index fluctuated within 10%, and the investor's portfolio for the same period - by 20%, then you need to figure out what's the matter. It might be worth buying assets from other industries or countries.

What indices are useful for a private investor

Each investor has his own portfolio, which depends on the investment strategy. Accordingly, people should keep track of a single index or a combination of both. But there are a few common indicators that will work for almost everyone.

Indices on the Russian market

Moscow Exchange Index, IMOEX. This is the main index on the Russian stock market, the indicator is calculated in rubles and revised every three months. In August 2021, the list includes shares of 44 companies, which are selected according to the greatest liquidity - the number of transactions made with them on the stock exchange. The top five include Sberbank, Gazprom, LUKOIL, Yandex and Norilsk Nickel.

For an investor, the indicator is useful in that it allows you to monitor the results of the entire stock market of the country and observe the dynamics of the most promising public companies.

RTS Index, RTSI. The same as the Moscow Exchange index: the same formulas and companies are included, but calculated in dollars.

The indicator allows you to look at the dynamics of the Russian market from the outside: in rubles everything may be fine, but in dollars it will collapse by 45.2%, as in 2014.

Moscow Exchange Blue Chip Index, MOEXBC. It includes selected, the most liquid and large companies of the Russian stock market - there are 15 of them in total.

Sometimes investors do not need the entire stock market, but only the most successful representatives. For example, to build a portfolio that will not fluctuate much in price and show a fairly stable return.

MSCI Russia Index. This is an indicator of the Russian stock market: similar to the Moscow Exchange index, but calculated by the international agency MSCI. The value is displayed in dollars, and the weight of the shares in the index depends on the size of the company and the availability of its securities for foreign investors.

Large foreign funds do not analyze every Russian company, but are guided by this indicator. Therefore, it is important for a private investor to keep an eye on him: in order to buy or sell assets on time, while their price has not changed much. The fact is that the funds are updating the composition of portfolios following the index, and this affects the entire Russian market.

Indices in the international market

S&P 500, SPX. Standard & Poor's agency calculates an index of the 500 largest companies that are traded on the US stock exchanges. Although there are more than 5,000 firms represented on them, these 500 best reflect the structure of the stock market: they account for about 80% of its capitalization.

The index is convenient for novice investors around the world: now the American stock market is the strongest, and this is a way to invest in it without diving into details. Legendary Warren Buffett has been recommending Berkshire Hathaway Annual Shareholders Meeting 2021 / Yahoo Finance to invest in this way for many years.

Warren Buffett CEO and Chairman of the Board of Directors of Berkshire Hathaway.

The best thing for most people is to have an S&P 500 index fund.

NASDAQ Composite, IXIC. This indicator is made by the American stock exchange NASDAQ, which houses the largest technology companies, electronics and software manufacturers. About a third of the index is occupied by the “big five”: Alphabet, Amazon, Apple, Facebook and Microsoft.

If an investor wants to invest in tech companies, then they'd better start with the NASDAQ Composite. It makes it easy to track tech giants, electronics manufacturers, financial and biotech companies - more than 3,000 enterprises from the United States in total.

Dow Jones Industrial Average, DJIA. The indicator is calculated by the same agency Standard & Poor's, but using a different methodology and for a smaller number of firms - the list includes the 30 largest American industrial companies.

The index will come in handy for investors who want to take a closer look at the stable blue chips, but not the Russian, but the American market.

FTSE 100, FTSE. The FTSE compiles an index based on the London Stock Exchange. The price of the shares of the 100 largest companies that are traded on it is taken as a basis.

If the investor does not want to be limited to the stock markets of Russia and the United States, then the FTSE 100 will show options for the best European companies.

There are several other indices that monitor the largest stock markets in the world. Typically, a private investor can buy shares of some of the leading companies directly, but most are available either through ETFs or through depositary receipts - securities that prove ownership of the shares.

It is also worth observing world indices in order to analyze trends in the global economy:

• Shanghai Composite, SSEC. The Shanghai Stock Exchange, the largest in China, calculates an index of all firms traded on it.
• Nikkei 225, N225. The index of the Tokyo Stock Exchange, which it calculates more easily than all others, is the arithmetic average of the prices of the 225 most liquid stocks.
• Deutscher Aktienindex, DAX. The stock index of the German market consists of 30 largest companies.
• Cotation Assistée en Continu 40, CAC. Index of 40 firms that are listed on the French exchange Euronext Paris.

How to invest based on the stock market index

If a person has several million rubles and wants to tinker with investments, then you can repeat the index yourself. The authors of the indicator always disclose which securities and in what proportions they used. You can buy stocks and bonds on the stock exchange, and then adjust the structure following the change in the index.

An easier and cheaper way to invest in an index is to buy shares in an index exchange-traded fund or ETF. The managers of such funds monitor the structure of an indicator and, if necessary, rebalance the portfolio.

Investing in an index fund is likely to be more profitable than trying to replicate the index yourself:

• Buy a share of the fund is cheap. As a rule, an investor pays from 2-5 to 7-9 thousand rubles per share, plus a brokerage commission for the purchase. In the case of independent investments, only commissions can take tens of thousands.
• Paying taxes is easy. Usually, the broker himself levies 13% tax on the investor's profits. If a person buys shares of foreign companies on his own, then he will have to understand the tax and legal regimes of different countries.
• The fund is diversified by default. When an investor buys a share, he immediately receives a share in dozens and hundreds of companies for a small amount. This means that the risk of losing money on fluctuations in the price of individual assets is low.

Index funds also have drawbacks to keep in mind. The main one is that they imperfectly repeat the indexes on which they are based. Let's say the indicator has changed slightly and the fund needs to buy additional shares of a company. But there are many funds working, and if everyone rushes to the exchange at one moment, then the shares of a particular company will rise in price: you will have to overpay, which will reduce profitability. And managers need to pay a broker a commission for the purchase - less than a private investor, but still. As a result, the index will show, say, 10% per annum, and the fund - only 8%.

The profitability is also reduced by the management commission charged by the fund, usually the latter ranges from 0, 06% to 1, 5-2% per annum. If the fund earns 3% and takes two-thirds, then investors will have only 1% yield - in fact, this is a loss, because inflation in Russia is five times higher About the consumer price index in December 2020 / Rosstat.

There are tens of thousands of ETFs in the world, 94 funds are available to a private investor in Russia. More than half follow an index. And not only stocks, but also bonds, Eurobonds, even commodities. The choice of a particular fund and asset class depends on the investor: his goals, capital, age, risk tolerance and other factors. In short, stocks and commodities will bring more money, but with risk, while bonds and Eurobonds are less profitable, but more reliable.

We will present several large funds that are available to a private investor in Russia.

Stock Index ETFs

• ITI Funds Russia Equity, RUSE. A foreign fund that tracks the RTS total yield index. This means that 44 largest Russian companies from 15 sectors of the economy are at the core. The price of their shares was converted from rubles to dollars, in which the fund reports on profitability. Taking into account dividends, and RUSE pays them, in 2020 it turned out 7.41% in dollars. For a currency, this is a high figure: for comparison, a dollar contribution will bring no more than 0, 1–0, 7% in Russian banks.
• Tinkoff iMOEX, TMOS. Follows the Moscow Exchange index. The composition is similar to the previous one, this is an investment in the entire Russian market at once, but the main currency is the ruble. In 2020, the fund showed a return of 36.02%.
• Responsible Investment, SBRI. Repeats the RSPP index. These are investments in Russian companies that comply with ESG principles: they care about the environment, employees and society as a whole. The list includes Rosneft and NLMK, as well as, for example, RusHydro and Magnit. From August 2020 to August 2021, the fund's share has risen in price by 35%.
• Dividend Aristocrats of the USA, FMUS. Buys shares of another fund, the American one, which tracks the Dow Jones Dividend 100 index. These are large and old companies that have been paying dividends for a long time and steadily, but growing slowly. The fund opened in January 2021 and has since grown by 10.9% in dollars.

Bond and Eurobond Index ETFs

• FinEx Tradable Russian Corporate Bonds, FXRB. Follows the Bloomberg Barclays Index, which includes corporate Eurobonds of 25-30 Russian companies. The index is based on a foreign one, and the fund is traded in both dollars and rubles, so the yield is different: 38.72% in dollars and 58.28% in rubles.
• Moscow Exchange's Sberbank Index of Russian Liquid Eurobonds, SBCB. Fund managers buy Eurobonds of the same large Russian companies, but their shares are weighted differently - in accordance with the index. Plus, about 12% of the fund is invested in Eurobonds of the Russian Federation. The annual yield is 1.4% in dollars.
• "MKB Index of the Moscow Exchange of government bonds (1-3 years)", SUGB. It directly follows the index of the same name, buys OFZs for rubles and reports on the profitability in them too. Since September 2020, the fund has lost 0.44% of its value.
• FinEx US TIPS UCITS, FXTP. Repeats the American Solactive index, which is based on the bonds of the US Federal Treasury. Since launching in May 2021, the fund has grown by 3% in dollars.

Index ETFs for currencies and commodities

• ATON Gold Miners, AMGM. It does not buy gold directly, but observes the NYSE Arca Gold Miners index: after it, it acquires shares of 50 gold mining companies. Since April 2021, the fund has fallen in price by 8, 48%. But this is not entirely indicative: if it had existed since the beginning of 2020, then the investor could earn 40% per annum - the price of gold jumped during the first wave of the coronavirus.
• FinEx Cash Equivalents UCITS, FXTB. Follows the Solactive GBS index and invests in short-term US bills. For the year they brought a loss of about 0.2%.

What is worth remembering

1. The stock index is an indicator that shows the dynamics of the value of a group of securities. Assets are grouped according to some criterion: country, sector of the economy or profitability.
2. Indices are compiled and calculated by stock exchanges or specialized agencies. It is based on data from hundreds of securities and complex mathematical formulas.
3. Investors use indices to compare the performance of their portfolios with the dynamics of the stock market.
4. There is no single correct index: everyone focuses on something different and is useful to different groups of investors.
5. You cannot directly invest in the stock index - it is just an indicator. But you can buy a BIF or ETF, which almost without deviations repeat the composition of the index.