There are all kinds of indexes! They are related to every type of investment that I talk about on here. When someone says the S&P 500 or the Dow Jones Industrial gained value what does this actually mean? This means that the stocks related to that index increased in value. There are a few ways that you should use indexes and index funds that I will go over in this page. I will have more detailed explanations about each index and what they represent and why you should track one over the other.
Benchmark Your Investments
The main reason why indexes are so popular is that they are used as a tool to benchmark performance. Benchmarks are comparisons of how your portfolio compares to the overall market. This isn’t a black or white area and the benchmark you choose should be very specific to your portfolio.
If you have a portfolio of large cap stocks, it might make scene to benchmark your performance against the S&P 500. This will give you a clear picture of how you are preforming. As an example, if the S&P 500 goes up by 10% and your portfolio makes 20%, great work. You just outperformed the market by 10%
Index Funds For Invest and Trading
The other reason you might want to look closely at the index funds is that there are ETF’s and mutual funds that mirror their performance. Back the the S&P 500 example, you can actually invest in a fund like $SPY and make the same return as the market. These have become popular because they can be actively traded and have application to passive investors.
The reason why these have became so popular is they are easy to use and the overall majority doesn’t make a greater return than the overall market. This is why people like Warren Buffet actually recommend buying an index fund and holding it in the long run. With this strategy you are guaranteed the market return year after year.
Advanced Technique: Hedging Against Market Risk
I am going to use the S&P 500 example again. If you own a portfolio of only S&P 500 stock, then you could use this technique to hedge against market risk. Market risk is the chance that the overall market will lose value. From the page Bull and Bear Markets I explain that a bear market happens less often but will wipe out your gains quick. In this situation, you could buy put options on $SPY as a hedge against the bear market when things look over bought.