All you Need to Know About Indices

An index is basically the statistical measure of changes in a securities market. So these indices can be an imaginary portfolio of stocks and bonds that represent a particular market. It can also represent just a portion of the market.

Every index in the stock or bond markets has its own methodology for calculation. Usually, minor changes in the index are more important than the actual numerical value that’s represented by the index. For example, if the FTSE 100 or Financial Times Stock Exchange 100 is at 7,876.30, it tells investors that the index is eight times its base level of 1000.

But this doesn’t tell you what has changed from the previous day. As a result, investors need to look at how much has fallen (or risen) on the index. This will be represented by a percentage.

What’s the Relationship Between Exchange-Traded Funds, Mutual Funds, and a Trading Index?

Exchange-traded funds (ETFs) and mutual funds sponsor the creation of portfolios that mirror the components of certain indices. This enables investors to purchase a security that’s likely to rise and fall in tandem with a segment of the stock market, or with it as a whole.

The most commonly used trading index is the Standard & Poor’s 500 and it’s often used as a benchmark for the stock market. It includes 70% of stocks traded in the U.S. Another popular trading index is the Dow Jones Industrial Average (DJIA) which represents 30% of all publicly traded companies in America.

What’s an Indexed Annuity?

Indexed annuities are closely connected to the trading index like mutual funds. But it doesn’t sponsor a fund, it’s rather a portfolio put together to mimic an index in question. They often feature a rate of return that closely follows a specific index, but usually have a cap on the return.

This means that if you buy an annuity indexed by the DJIA with a cap of 5%, the return you will receive will be between 0 and 5%. Further, your return will also depend on the annual changes to the index.

It is popular among investors as it allows them to purchase securities that can grow with the whole market or broader market segments.

These indices are not limited to stocks and bonds, there’s also what’s known as a mortgage index. These are adjustable-rate mortgages (ARMs) where interest rates are adjusted during the lifespan of the housing loan. The London Interbank Offer Rate of LIBOR is probably the most popular mortgage index.