Market indexes attempt to give an overall picture of the behavior of the market by tracking the performance of a representative sample of stocks. Different indexes have different focuses. The Russell 3000 samples more of the smaller companies than the S&P 500.
Index mutual funds and ETFs track specific indexes but, as you’ll notice in their disclosures, it is impossible to invest directly in an index; they only follow the index by investing in as many of the companies as possible and minimizing lag as much as they can. Indexes give numerical values for the progressive fluctuations in the price action for specific sets of stocks.
There are various famous market indexes, and each one tends to focus on a slightly different section of the overall market. Some examples are the Dow Jones Industrial Average (DJIA), the S&P 500, and the Russell 3000. Many of these are considered representative of the overall market, but some are weighted more heavily toward companies of a certain size or in a certain sector.
Indexes are calculated and published by industry research companies, and they tend to weight their calculations according to the size of the market capitalization of the company. The idea is to see how the aggregate money in the market is doing. There are also indexes that are specific to different asset classes or geographical regions, and these can get very narrow in their focus.
This allows investors and analysts to keep up with how all sorts of different kinds of asset classes are doing as a group. Indexes are also used as benchmarks to compare the performance of a particular stock to the performance of its peers on average. Index mutual funds and ETFs attempt to track the index performance as closely as possible by buying shares of all the companies in the index that are publicly traded.
By actually holding the stocks, their funds gain and lose value along with the index, but there is usually some tracking error or lag caused by logistical problems. Investors buy shares which represent a proportional undivided interest in the Net Asset Value of the fund. They will always have a disclaimer that lets you know that it is impossible to invest directly in an index, since the index is only data and not actual assets.
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