What is an “index”, and how to use it while investing?

Index is a score that represents the value of total securities in a given area of a market. Simply put, it is a grade sheet of a class.

Imagine that markets consist of different classes. For example, from the US market, Standard & Poor's 500 Index specifically focuses on 500 leading companies that are publicly traded. It is shortly called as S&P 500, and it is used as a benchmark to analyze the performance of the US market in general. 

In addition to analyzing the performance of the US economy, S&P 500 is also used for many investors and hedge fund managers to assess their own performance. A hedge fund manager who is not able to outperform S&P 500 is basically failing, as potential investors would invest in S&P 500 itself to generate larger returns rather than providing their capital to a hedge fund.

How to invest in an index? There are numerous ETFs that are fixed on indexes provided by large investment firms to be bought. If you are not sure about what an ETF is, read this in 1 minute.

As an example, Vanguard S&P 500 ETF (VOO) is provided by Vanguard, and can easily be bought and sold as an asset. It fully reflects the dynamics of S&P 500, and that is why it is not an actively managed ETF. You invest your money in such an ETF, Vanguard uses your capital to invest in S&P 500 companies, and you make those companies work for you to generate passive income while providing them capital to improve their operations. Win-win scenario there.

S&P 500 was just an example of an index. Russell 3000 is another well-known index. It measures the performance of the largest 3000 companies in the US market, which actually constitute 96% of the investable US equity market. It covers a broader scope than S&P 500, and is also used to analyze the performance of the general US market. 

As an investor, we should know the performance of indexes. As they are not limited to the US market, indexes such as Nikkei 225, NIFTY 50, STOXX 50 provide valuable information on how their respective markets perform.

Analyzing them in short-term and long-term perspectives also gives valuable insights on macroeconomy dynamics around the world.

For checking the performance of indexes, I suggest the simplest option: Google Finance. You may easily find the major indexes there with general information and news about them.