Indices: A single number for a whole market

Every evening, you are told the stock market went up or down. But the market is thousands of shares. Who works out the average?

An index. A chosen basket, and a calculation rule. Change the basket or the rule, and the number changes.

The most famous of the old indices is the Dow Jones. Charles Dow launched it in eighteen ninety-six, with twelve stocks.

Today it has thirty. And it keeps a rule from another age: it adds up the share prices.

The result: an expensive share weighs more than a cheap one. Even if the company is smaller.

Say two shares. One is worth three hundred dollars, the other thirty. The average is one hundred and sixty-five.

The expensive one rises ten per cent: the index gains more than nine per cent.

The cheap one rises ten per cent: the index moves less than one per cent. Same rise, an effect ten times smaller.

A share's price says nothing about the size of the company. That is why professionals look elsewhere.

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Their benchmark is the S and P five hundred. Five hundred large American companies, weighted by their stock market value.

And they are not chosen by a formula. A committee meets and decides who comes in and who goes out.

There are criteria: size, profits, trading. But in the end, humans make the call.

To look beyond the United States, people cite the MSCI World. The name promises the whole world.

In reality: twenty-three countries, all developed. Not China, not India, not Brazil. No emerging country.

And the United States alone makes up well over half. The index's world is not the one on the map.

In France, the number in the paper is the CAC forty. Forty large stocks on the Paris exchange.

One detail matters enormously: the CAC forty usually quoted does not reinvest dividends. It only tracks prices.

Yet a shareholder receives those dividends. There is a version that counts them: it is called dividends reinvested.

For the example: one thousand euros, a three per cent rise a year, for thirty years. Two thousand four hundred and twenty-seven euros.

Add three per cent of dividends reinvested each year: five thousand seven hundred and forty-three euros. More than double.

Comparing your investment to the CAC forty without dividends is measuring yourself against a runner carrying less weight.

Remember three questions for any index. Who is in the basket? How is each one weighted? Are dividends counted?

An index is not the market. It is a summary, written with rules. And each rule tells a slightly different story.