What is 'Indexing'

Indexing is broadly referred to as an indicator or measure of something. In the financial markets, indexing can be used as a statistical measure for tracking economic data, a methodology for grouping a specific market segment or as an investment management strategy for passive investments.

BREAKING DOWN 'Indexing'

In Financial Markets

Indexing is used in the financial market as a statistical measure for tracking economic data. Indexes created by economists provide some of the market’s leading indicators for economic trends. Economic indexes closely followed in the financial markets include the Purchasing Managers' Manufacturing Index, the Institute for Supply Management’s Manufacturing Index and the Index of Leading Economic Indicators.

Statistical indexes may also be used as a gauge for linking values. The cost of living adjustment (COLA) is a statistical measure obtained through analysis of the Consumer Price Index. Many pension plans use COLA and the Consumer Price Index as a measure for retirement benefit payout adjustments with the adjustment using inflation-based indexing measures.

In The Investment Market

In the investment market, indexes exist to represent specific market segments. Leading market indexes in the U.S. are the Dow Jones Industrial Average and the S&P 500. Indexes are constructed with specified methodologies. The Dow Jones Industrial Average is a price-weighted index giving greater weight to stocks in the index with a higher price. The S&P 500 Index is a market-capitalization weighted index giving greater weight to stocks in the S&P 500 Index with a higher market capitalization. Index providers have numerous methodologies for constructing investment market indexes.

Passive Investing and Tracker Funds

Indexing is broadly known in the investment industry as a passive investment strategy for gaining targeted exposure to a specified market segment. The majority of active investment managers typically do not consistently beat index benchmarks. Investing in a targeted segment of the market for capital appreciation or as a long-term investment can be expensive given the trading costs associated with buying individual securities. Therefore, indexing is a popular option for many investors. An investor can achieve the same risk and return of an index by investing in an index fund. Most index funds have an expense ratio ranging from 0.10% to 0.25%. Index funds can be constructed using individual stocks and bonds. They can also be managed as a fund of funds with mutual funds or exchange-traded funds as their base holdings.

Index funds can also be called tracker funds. More complex indexing strategies may seek to replicate the holdings and return of a customized index. Customized index tracking funds have evolved as a low-cost investment option for investing in a screened subset of securities. Customized index funds track customized or screened indexes that are constructed based on a range of filters including fundamentals, dividends, growth characteristics and more.

Investors have many indexed investment options to choose from within the investment industry. Two of the leading index fund providers are State Street Global Advisors and BlackRock. State Street Global Advisors offers a wide range of index funds through its SPDR index series. BlackRock offers numerous index funds through its iShares series.

RELATED TERMS
  1. Index Fund

    An index fund is a portfolio of stocks or bonds that is designed ...
  2. Composite

    A composite is a grouping of equities, indexes or other factors ...
  3. Total Return Index

    Total return indexes include any dividends in the calculation ...
  4. Tracker Fund

    A tracker fund is an index fund that tracks a broad market index ...
  5. Dow Jones U.S. Total Market Index

    The Dow Jones U.S. Total Market Index is a market-capitalization-weighted ...
  6. Capitalization-Weighted Index

    Capitalization-weighted index is a market index in which stocks ...
Related Articles
  1. Investing

    5 Things You Need To Know About Index Funds

    Index funds, at their best, offer a low-cost way for investors to track popular stock and bond market indexes. But not all index funds are created equally.
  2. Financial Advisor

    The 4 Best U.S. Equity Index Mutual Funds

    Find out which four index mutual funds are among the best U.S. equities index mutual funds for core holdings in your investment portfolio.
  3. Investing

    The Lowdown On Index Funds

    If you can't beat the market, why not join it? Read on to see what your options are.
  4. Trading

    Index Options: A How-To Guide

    Index options, financial derivatives that derive their value from a stock index, can provide stability and peace of mind for less risky investors.
  5. Investing

    Why Index Fund Investing Works

    Over time, index fund investing gained traction and ultimately reshaped the industry. Today, these once obscure funds comprise more than 22 percent of equity mutual fund assets, according to ...
  6. Investing

    ETF for FTSE High Dividend Yield Index (VYM)

    Discover a high dividend yielding exchange-traded fund (ETF) that almost perfectly mimics the performance and behavior of the FTSE High Dividend Yield Index.
RELATED FAQS
  1. How can I buy an S&P 500 fund?

    Looking for access to the S&P 500? Learn how to access an S&P 500 index fund or ETF. Read Answer >>
  2. Can an Index Fund Investor Lose Everything?

    There is almost zero chance that any index fund could ever lose all of its value. Read Answer >>
  3. What is index option trading and how does it work?

    Learn about stock index options, including differences between single stock options and index options, and understand different ... Read Answer >>
Hot Definitions
  1. Price-Earnings Ratio - P/E Ratio

    The Price-to-Earnings Ratio or P/E ratio is a ratio for valuing a company that measures its current share price relative ...
  2. Internal Rate of Return - IRR

    Internal Rate of Return (IRR) is a metric used in capital budgeting to estimate the profitability of potential investments.
  3. Limit Order

    An order placed with a brokerage to buy or sell a set number of shares at a specified price or better.
  4. Current Ratio

    The current ratio is a liquidity ratio that measures a company's ability to pay short-term and long-term obligations.
  5. Return on Investment (ROI)

    Return on Investment (ROI) is a performance measure used to evaluate the efficiency of an investment or compare the efficiency ...
  6. Interest Coverage Ratio

    The interest coverage ratio is a debt ratio and profitability ratio used to determine how easily a company can pay interest ...
Trading Center