What Is a Broad-Based Index?
A broad-based index is designed to reflect the movement of a group of stocks or an entire market.
The broad-based index with the fewest stocks is the Dow Jones Industrial Average (DJIA), with just 30 stocks included in the index. One of the largest is the Wilshire 5000 Total Market Index. Other examples of broad-based indexes include the S&P 500 Index, the Russell 3000 Index, the AMEX Major Market Index, and the NASDAQ Composite Index.
- A broad-based index is a benchmark used to track the performance of a group of stocks.
- Owning the securities that make up a broad-based index can add diversification to a portfolio.
- Many market indexes are market-value weighted, which means that large companies have a greater influence on the index's price changes compared to smaller companies.
- Examples of broad-based indices range from the S&P 500 and Nasdaq Composite to the Wilshire 5000 and Russell 3000.
Understanding Broad-Based Indexes
An index is a tool used to track the performance in a basket of stocks. The methodology used to compute an index can vary, but the ultimate purpose of each one is to have a benchmark to view the average price moves of the group over a period of time. Investors who want the maximum benefit of diversification can invest in securities that are included in an index or invest in other financial products—such as some index funds—that are made up of the stocks within the index.
Securities based on broad-based indexes, like index funds, allow investors to effectively own the same basket of stocks contained in a major index while committing relatively small amounts of capital. An example is the ETF called SPDR 500 Trust (SPY), which holds the same five hundred names as the S&P 500 Index. Investors can buy and sell shares of SPY as if buying and selling shares of stock. Each share represents ownership interest in the components of the S&P 500 Index, but the cost of each shares is a fraction of the cost of buying all five hundred stocks at once.
Examples of Broad-Based Indexes
The Dow Jones Industrial Average, which is mentioned regularly by news commentators covering the stock market, has one of the fewest numbers of stocks among broad-based indexes. It is also the second-oldest U.S. market index after the Dow Jones Transportation Average (DJTA). While the transportation average (initially known as the Dow Jones Railroad Average) was first published in 1884, the industrial average was not calculated until 1896.
The Industrial portion of the name is largely historical, as many of the modern components have little to do with the heavy industry of the late 1800s. It was initially conceived by Wall Street Journal editor and Dow Jones & Company co-founder Charles Dow. It is now owned by S&P Dow Jones Indices, which is majority-owned by S&P Global.
The industrial average is the best known of the Dow Averages, which are named after Dow and one of his business associates, statistician Edward Jones. Although designed to reflect the strength of the U.S. economy, the index's performance is heavily influenced by global corporate and economic reports as well as domestic and foreign political events. War, terrorism, and natural disasters can all impact the Dow as well.
Wilshire Associates, an investment management company, started the Wilshire 5000 Total Market Index in 1974, naming it for the approximate number of issues it included at the time. It was renamed the "Dow Jones Wilshire 5000" in April 2004, after Dow Jones & Company assumed responsibility for its calculation and maintenance. On March 31, 2009, the index reverted back to the Wilshire 5000 name when Wilshire Associates terminated its deal with Dow Jones.
While the original Wilshire 5000 Total Market Index had roughly 5,000 stocks, the list has shrunk to include around 3,500 stocks today. Like the S&P 500, the index is calculated using a market-value weighted methodology, which means that larger companies will have a greater influence on the performance of the index compared to smaller ones. The Dow Jones Industrial Average, on the other hand, is price-weighted and higher-priced stocks have more sway in the index compared to low-priced stocks.