Share Market Index

A share market index is a basket of stocks, weighted and totalled, that measures how a market is performing. The ASX 200 holds the 200 largest companies by market capitalisation; the All Ordinaries holds the 500 largest and is the older, broader measure. The index is weighted by size, which means the biggest companies move it the most - the four major banks together are roughly a fifth of the ASX 200, and one of them alone is close to a tenth. The index is a sample, not the population: 200 names out of more than 2,000 listed.

The Australian detail worth knowing is the two versions of the number. The price index - the one the news quotes - excludes dividends; the accumulation index includes them, and the gap is roughly 4 percent a year. An index fund buys the constituents at their weights and tracks the basket, and the index fund entry covers the wrapper. Every managed fund and ETF quotes its performance against an index benchmark, which makes the index the scoreboard the industry is judged on.

The basket is the mechanism. The index provider sizes each stock's weight by market capitalisation - price multiplied by shares on issue - and rebalances the weights as the sizes change. A company worth a tenth of the index moves the index a tenth of its own move; a stock at half a percent barely registers. The concentration is arithmetic, not opinion: the four major banks together are roughly a fifth of the ASX 200, and the miners add another block.

The two versions of the number are the second mechanism. The price index adds up the prices and ignores the dividends; the accumulation index reinvests them, and the difference compounds at roughly 4 percent a year. Over twenty years, the accumulation version nearly doubles the price version's outcome - the news quotes the smaller number, and the portfolio earns the larger one. The investment calculator prices the gap at any rate and term.

The tracking is the third mechanism. An index fund buys the constituents at their weights, holds them as the weights drift, and delivers the index's return minus a small fee. The All Ordinaries adds the next tier of small caps below the 200, which historically underperformed the large caps - the two indices told different stories over the last decade. The benchmark names which basket applies, and the portfolio diversification calculator measures the concentration in any holding that tracks it.

For an Australian reader, the index is the scoreboard behind every fund comparison and the number the news quotes twice a day. The confusion that costs money is the price index. Comparing a total-return fund against the news number makes the fund look 4 percent a year underperforming when it is tracking perfectly. MoneySmart's guidance on investing treats the index as the benchmark, and the concentration - banks and miners at half the index - is the bet the index name never declares. The blue chip entry covers the same concentration from the company side.

A colleague named Brent (yes, that Brent) spent a year convinced his index fund was underperforming, because the news quoted the ASX 200 price index and his statements showed the accumulation version. The gap was the dividends; the fund was tracking the basket perfectly. The year of doubt cost him a switch he spent months undoing. The highest-leverage thing most Australians can do is compare like with like - total return against accumulation index - and run the investment calculator on the gap the dividends make over twenty years.