The S&P and Dow Jones indices are often thought as of “markets”, while in reality they are a collection of stocks that have been grouped together based off certain characteristics and qualifications. Standard and Poor’s (S&P) creates indices by measuring the value of stocks of the top corporations by market capitalization on the New York Stock Exchange (NYSE).
"A low-cost [index] fund is the most sensible equity investment for the great majority of investors. My mentor, Ben Graham, took this position many years ago, and everything I have seen since convinces me of its truth."
~ Warren Buffet
In basic terms an index fund reflects the growth or decline of an economy. Investing in the S&P 500, for example, is like betting on the 500 top public companies in the United States. And it’s done pretty well over time.
Most people are looking for the next global trend. They want to discover the next Google or Amazon. They want to invest in a cheap stock, wait a few years while the price per share goes up a few hundred dollars, and then suddenly end up on yachts eating caviar.
For most of us who are not the best at predicting the future, index funds might be our closest bet to securing positive stock market exposure. Since we’ve been using the S&P 500 as the only example on indices so far, here’s a Reddit post discussing the general upward trend of the S&P500 since 1870. When an investor purchases a security made of their S&P 500 index, the investor’s money is allocated to the top 500 large cap companies (each valued more than $10 billion) on the NYSE.
Check out this Freakonomics podcast to learn more about index funds and how they work. The intention of index funds is to generate a price that provides how the stock market and economy are doing at a glance.
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