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MARKET INDEXES

Investors can choose from an enormous number of different securities. Currently, about 3,100 common stocks trade on the New York Stock Exchange, about 1,000 are traded on the American Stock Exchange and regional exchanges, and more than 5,000 are traded by a network of dealers linked by computer terminals and telephones.1 Financial analysts can t track every stock, so they rely on market indexes to summarize

the return on different classes of securities. The best-known stock market index

in the United States is the Dow Jones Industrial Average, generally known as the Dow. The Dow tracks the performance of a portfolio that holds one share in each of 30 large firms. For example, suppose that the Dow starts the day at a value of 9,000 and then rises by 90 points to a new value of 9,090. Investors who own one share in each of the 30 companies make a capital gain of 90/9,000 = .01, or 1 percent.2

The Dow Jones Industrial Average was first computed in 1896. Most people are used to it and expect to hear it on the 6 o clock news. However, it is far from the best measure of the performance of the stock market. First, with only 30 large industrial stocks, it is not representative of the performance of stocks generally. Second, investors don t usually hold an equal number of shares in each company. For example, in 1999 there were 3.3 billion shares in General Electric and only 1.1 billion in Du Pont. So on average investors did not hold the same number of shares in the two firms. Instead, they held three times as many shares in General Electric as in Du Pont. It doesn t make sense, therefore, to look at an index that measures the performance of a portfolio with an equal number of shares in the two firms.

The Standard & Poor s Composite Index, better known as the S&P 500, includes the stocks of 500 major companies and is therefore a more comprehensive index than the Dow. Also, it measures the performance of a portfolio that holds shares in each firm in proportion to the number of shares that have been issued to investors. For example, the S&P portfolio would hold three times as many shares in General Electric as Du Pont. Thus the S&P 500 shows the average performance of investors in the 500 firms. Only a small proportion of the 9,000 or so publicly traded companies are represented in the S&P 500. However, these firms are among the largest in the country and they account for roughly 70 percent of the stocks traded. Therefore, success for professional investors usually means beating the S&P.

Some stock market indexes, such as the Wilshire 5000, include an even larger number of stocks, while others focus on special groups of stocks such as the stocks of small companies. There are also stock market indexes for other countries, such as the Nikkei Index for Tokyo and the Financial Times (FT) Index for London. Morgan Stanley Capital International (MSCI) even computes a world stock market index. The Financial Times Company and Standard & Poor s have combined to produce their own world index.

MARKET INDEX

Measure of the investment performance of the overall market.

DOW JONES INDUSTRIAL AVERAGE Index of the investment performance of a portfolio of 30 blue-chip stocks.

STANDARD & POOR S COMPOSITE INDEX Index of the investment performance of a portfolio of 500 large stocks. Also called the S&P 500.