A Primer on U.S. Stock Price Indices
The measurement of the "average" price of common stocks is a matter of widespread interest. Investors want to know how "the market" is doing, and to be able to compare their returns with a meaningful benchmark. Money managers often have their compensation tied to performance, typically measured by comparing their results to a benchmark portfolio, so they and their clients are interested in the benchmark portfolio's returns. And policymakers want to judge the potential for sudden adjustments in stock prices when differences from "fundamental value" emerge.
This article discusses some of the issues in constructing and interpreting stock price indices. The author focuses on the most widely used indices: the Dow Jones Industrial Average, the Standard , Poor's 500, the Russell 2000, the NASDAQ Composite, and the Wilshire 5000. Each of these indices is intended to be a benchmark portfolio for a different segment of the universe of common stocks. He compares the movements in the five popular indices over the last two decades and examines the correlations between the returns on each of the stock price indices. His findings suggest that the Dow 30, the S&P 500, and the Wilshire 5000 are similar and capture the movements in a different segment of the market than do the NASDAQ Composite and the Russell 2000.