DEFINITION of 'Constituent'
A constituent is typically a stock or company that is part of a larger index, such as the S&P 500 or Dow Jones Industrial Average. The aggregate of all the constituents make up an index, and generally each constituent has to meet certain requirements pertaining to market cap, market exposure and liquidity, and be selected to be included in an index.
BREAKING DOWN 'Constituent'
A few of the largest market indexes in the United States include the Dow Jones Industrial Average, the Dow Jones Transportation Average. the Nasdaq Composite Index and the New York Stock Exchange (NYSE) Composite Index.
Indexes serve a number of important functions in the economy, including tracking the performance of particular markets or sectors of the stock market or economy, giving shape and substance to index, mutual and exchange-traded funds (ETFs), and providing investors and portfolio managers with benchmarks to evaluate their own decisions. By gaining entrance into a market index, a constituent stock or company receives the benefit of increased exposure, confidence and attractiveness.
Requirements of Constituents
Criteria for being a constituent of a market index vary from one index to another. The Dow Jones Industrial Average is comprised of 30 of the largest and most well-known American corporations (listed mainly on the NYSE), spanning across many industries, with each constituent having a weight on the overall index proportional to its price. The Nasdaq Composite Index and NYSE Composite Index track the performance of all equities listed on each stock exchange. The weight that each individual constituent has on the overall index is based on market capitalization, with both price return and dividend yield of each constituent factoring into movements of the index.
As a market index becomes smaller, requirements of constituents usually lessen in market cap size and narrow by sector. Examples of smaller and more specific market indexes include the Nasdaq Computer Index, the Morgan Stanley High-Technology 35 Index, the PHLX Semiconductor Index, the PHLX Gold/Silver Index, the NYSEARCA Oil Index and the Russell 2000 Index. The PHLX Semiconductor Index includes companies such as Intel Corporation, Skyworks Solutions, Linear Technology and Infinera Corporation; constituents that are considerably less well-known than those of the Dow Jones Industrial Average.
Benefits of Index Funds
Funds based on an index such as the S&P 500 are attractive to investors looking to generate a modest return on investment while diversifying their portfolio and minimizing their exposure to risk. Index funds generally offer low risk and steady growth, while their disadvantages include limited flexibility and less big gains.