What is a market index and how might it affect your investments?

Investment / 31.05.2022

Understanding How a Market Index Can Affect Your Investment

The world of investment is vast and can seem complicated for a lot of newcomers. That said, all it takes is a little time to understand what’s happening, the jargon, and the best practices you need to make the right investment decisions.

One of these “complicated” concepts is that of the market index.

In this article, we’ll cover what market indices are and more importantly, how they might affect your investments.

What is a market index?

A market index is a hypothetical investment portfolio that represents a segment of the financial market.

In simple terms, a market index is something that can help you track the relative changes in the value of the shares that are under that index.

Investors follow different market indexes to gauge market movements.

You might be familiar with capital indices.

These are what we normally see on news reports. Trackers are meant to track the total market value of the different companies in the index.

What this shows us then is how larger companies have the tendency to dictate the movement of an index. Popular examples of these kinds of indices include:

  • Australia’s All Ordinaries Index (the 500 largest companies in Australia)
  • The U.S. Dow Jones Industrial Index (which tracks the 30 largest industrial companies)
  • The U.S. S&P 500 (Largest 500 companies in the U.S.)

Accumulation indices, meanwhile, are indices that are calculated with the assumption that the dividends of these companies are to be reinvested into the company again. This means that accumulation indices compound the returns, accumulating the value of the companies. The effect is a big difference when looking at the performance of particular investments.

 Performance of ASX Listed Companies vs. U.S. Stock Market

The different types of indices explain the difference between the perceived performance of the Australian share market relative to the US market.

American-based companies pay very low dividends compared to Australian companies, so U.S. indices behave a bit more like accumulation indices than their Australian counterparts.

What is the Market Index ASX?

The S&P/ASX 200 (XJO) Index is Australia’s leading share market index and contains the top 200 ASX listed companies. It is used as a reference point to measure the combined performance of their shares and is considered the benchmark of Australian equity performance.

How Indices Affect Your Investments

Since indices are trackers, they communicate the past performance of particular investments and are useful to predict the future performance of investment portfolios.

Indexes provide investors with a simplified snapshot of a large sector, without having to examine every single asset in that index.

However, it’s important to remember that market indices are only a guide. Their accuracy to your personal financial situation will depend on how closely your portfolio matches the market index.

It’s also important to consider the following when making an investment decision:

  • The fees associated with your investments (do you pay brokerage fees?)
  • The financial products you invest in
  • How much exposure to risk you are comfortable with
  • Whether you want to invest passively to actively
  • Your investment timeline range (are you investing for a particular date or financial objectives?)
  • How diversified your portfolio is (how varied is your asset distribution?)

Of course, if you’re following the golden rule of investment – diversification – your precious savings and superannuation will likely be invested in both Australian and international share markets as well as cash, fixed interest and property.

By spreading your investment, you are giving yourself more chances to gain something through the year, rather than relying on one good one to power through.

Any given index can then only affect the performance of a part of your portfolio. Nonetheless, if you’re like most people, you’ll want to see the share market arrows on the TV pointing up and not down each day!

Seek Professional Advice from TNR Wealth Management

Whether you are looking for holistic investment advice or specific financial product advice, our Experienced Financial Advisers can help.

Are you looking for a financial adviser in Byron Bay? TNR Wealth Management can help you with your investment decisions.

Book an appointment with our team today.

For more information or to speak to one of our Financial Advisers please contact TNR Wealth Management on 02 6621 8544.

Disclaimer

Past performance is not a reliable indicator of future performance. The information and any advice in this publication does not take into account your personal objectives, financial situation or needs and so you should consider its appropriateness having regard to these factors before acting on it. This article may contain material provided directly by third parties and is given in good faith and has been derived from sources believed to be reliable but has not been independently verified. It is important that your personal circumstances are taken into account before making any financial decision and we recommend you seek detailed and specific advice from a suitably qualified adviser before acting on any information or advice in this publication. Any taxation position described in this publication is general and should only be used as a guide. It does not constitute tax advice and is based on current laws and our interpretation. You should consult a registered tax agent for specific tax advice on your circumstances.