Buying the Index
The term buying the index refers to purchasing stocks in the same proportion as a stock market index. If an investor buys the index, the portfolio they assemble should provide the same return as the index they are attempting to replicate.
When investors discuss the stock market, they typically refer to one of the more popular indices such as the NASDAQ Composite, the Dow Jones Industrial Average (DJIA), or the S&P 500. While the DJIA contains a relatively small number of bellwether stocks, the S&P 500 and NASDAQ Composite are composed of a much larger number of securities. In all three of these cases, the index is believed to be a good indicator of the relative health of the overall stock market.
Investors wishing to achieve results that are similar to an index can do so by buying the index in several ways:
- Assemble a Portfolio: also referred to as indexing, the investor has the option of purchasing the same stocks as those in the index in the same weights as they appear in the index. This method is not only time consuming, it’s also relatively inefficient from a fees standpoint too.
- Purchase a Mutual Fund: a more efficient way to buy the index is through the purchase of an index fund, essentially purchasing a portfolio that contains the same stocks as the index in the same weight as the index.
- Purchase an EFT: perhaps the most cost-efficient manner to buy the index due to lower management fees, an exchange-traded fund (EFT) is similar to a mutual fund except they are traded on an exchange, just like common stocks.