E is for Evaluating Indexes as Benchmarks when Creating your Investment Portfolio

E is for Evaluating Indexes as Benchmarks when Creating your Investment Portfolio

evaluating indexes as benchmarks when creating your investment portfolio

Benchmarks are essential to evaluate when you are investing your hard-earned money for your future. A benchmark measures and analyzes a given portfolio’s allocation, risk, and return. 

Individual funds and investment portfolios will usually have established benchmarks for standard analysis. So a variety of benchmarks are used to understand how a portfolio performs against various market segments.

A portfolio with a specific market segment is important when using benchmarks. An index is a selection of securities that help provide a glimpse into the broader stock market. For example, its calculation is based on the prices of a collection of similar stocks. This helps give a general idea of how the market is performing in this particular market or segment.  The index is being referred to when you hear the market is up 100 points. But keep in mind there are many U.S. indices.

Below are a few major indices:

Dow Jones Industrial Average (DJIA)

The Dow Jones is the oldest and most renowned index. It is an index of 30 “Blue Chip” stocks of U.S. industrial companies, which includes a broad range of companies. Therefore, these stocks are heavily traded. And therefore, represent a majority of market volume, which may provide a good indicator of the entire market. The DJIA is not a weighted index and does not factor in market capitalization.

S&P 500 Composite Stock Price Index

The S & P 500 is a capitalization-weighted index of 500 widely held stocks. And these stocks account for 70% of the entire market and are a sample of leading industries within the U.S. Economy. Some stocks are chosen for market size, liquidity, and industry group representation. Many financial professionals use the S&P 500’s performance as a benchmark.

Nasdaq Composite Index

This index is a market-capitalization-weighted index of all stocks traded on the Nasdaq. Technology stocks make up a significant portion of this index. Also, it incorporates financial, industrial, insurance, etc. Stocks and includes speculative companies with small market capitalizations.

The above indices are only a few of the thousands of market indices. There are indices for every credible sector of the economy, investment style, different asset classes, and market capitalization size. Indices are typically related by some commonality. And each index focuses on providing highly specific or very general information. Investors and financial managers use indices to describe the market and compare the return on specific investments. 

The SEC does not regulate the content of these indices so go to Morningstar’s website, Nasdaq website, or Standard & Poor’s website for details. Contact your trusted financial advisor and discuss how they use indices to create benchmarks for investment measurement. Or read the Wall Street Journal!.

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