All Indexes Are Not Created Equal

The virtues of investing in index funds have gotten a lot of good press over the years (including some from yours truly). Yet in our ever competitive American marketplace, new index fund products roll out based on an ever-growing array of underlying indices. Normally competition is a good thing, but sometimes it can create downright confusing problems for the typical investor.

For instance, most readers who invest in the stock market (directly in stocks or through mutual funds) have heard of the S&P 500, or the Standard and Poor’s 500. This index tracks the stocks of 500 of the largest companies in America, and most are household names (IBM, Hewlett Packard, McDonald’s, General Motors, Amazon, etc.). In the investment world, these are called “large company” stocks. So you would think that the S&P 500 would do an adequate job of capturing the performance of large company stocks on an overall basis.

But not everyone agrees with S&P’s classification system. In fact, there are other large company indexes out there. Morningstar has one (Morningstar is a mutual fund research company), Russell has one (another firm like S&P that tracks stock performance), and the venerable Dow Jones company has one. Some of these indexes have 500 stocks in them, while others go all the way up to 1,000 stocks.

So if you want to buy an index fund that tracks large company U.S. stocks, which underlying index should you choose? I’ve only mentioned four choices so far. If you want to slice and dice the large company stock market some other ways (such as by “growth” or “value,”), now we’re up to 14 indexes. Remember in the good old days, if you wanted to know how “the market” was doing, you listened to the evening news for the change in the Dow Jones Industrial Average or the S&P 500.

But today, you have at least 14 indexes tracking “the market.” If we add mid-size companies and even small companies, add another 24+ indexes to the mix. So just “buy an index fund” is no longer the simple advice it used to be. All these extra index choices, and the underlying investment products built around them, present lots of new and exciting investment opportunities. And I haven’t even mentioned bond indexes, real estate indexes, commodity indexes, etc.

To choose wisely, do your homework or hire someone to do it for you. There is lots of information available on the web, if you’re willing to do the research yourself. But nowadays, to buy an index fund just takes a little more time and persistence.

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About Mike Wilson

Michael L. Wilson, MBA, CFP®, CRC®, is the owner of Integrity Financial Planning. Prior to founding Integrity in 1998, he worked for two years as a faculty member at the College for Financial Planning in Denver, training other financial advisors. Mike has 10 years of experience in the mutual fund industry, having worked with Fidelity Investments and Invesco Mutual Funds. He holds an MBA in Finance from Baylor University. Learn more about his work at www.integrityplanner.com.
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