Indexes and Index Funds -- So What's the Difference?

Arthur Stein Financial, LLC |

S&P 500 Index funds are one of the most common investments for individual investors. But what are “index funds” and how do they compare to “indexes?”

Indexes and an index funds are different. Cousins, maybe, but not the same.
 
Investment indexes represent a group of stocks or bonds and a percentage allocation. Indexes are constructed to track a certain segment of the stock or bond markets. You cannot invest in an index. You can only invest in an index fund. Indexes only exist on paper and computer screens.
 
Index companies decide which stocks or bonds go into an index. Fund companies then pay a fee to the index companies.to use an index.
 
The S&P 500 Index is composed of 500 of the largest companies in the US stock market. The stocks are chosen by a committee. The S&P 500 represents approximately 80% of the total value of the stocks in the US stock market.
 
Another index, called the S&P Dow Jones US Completion Index includes the stocks of almost all US companies minus the 500 in the S&P 500 Index. Those two indexes cover most of the US stock market with no overlap.
 
 
Criteria for inclusion of a company's stock in  the S&P 500 Index include being domiciled in the US, worth more than $6 billion, sufficiently liquid, reasonable share price, public float of at least 50% (don’t ask), sector balance and historical earnings.
 
Reported index returns may be different than the reported index fund returns. It depends upon whether price return or total return is quoted for the index.
  • Price return: Change in the index’s price without crediting income from dividends, capital gains and interest.
  • Total return: Includes the change in the price of the index plus the benefit of reinvesting dividends, capital gains and interest. Total Return is a better measure of returns to investors.
 
For instance, during the first six months of 2017:
  • The S&P 500 Index price increased from 2239 to 2423. So the Price Return was 8.2.
  • The share price of an S&P 500 mutual fund increased 9.4% when the benefit of reinvested dividends and capital gains were included. That is Total Return.
The table below illustrates that the percentage changes in the S&P 500 Index were 16% to 28% lower when dividends were not included. 
 
 
The percentage invested in each of the 500 stocks is based upon the total value of their shares as a percentage of the total value of the Index. Share value is the number of shares being traded times the share price. The table below lists the largest and smallest companies in the S&P 500 Index and corresponding percentages of total Index value:
 
 
You don’t need to understand all these details to be an informed investor. What you should understand is that:
  • S&P 500 Index Funds invest in the stocks of large US companies, which represent about 80% of the total value of the US stock market.
  • Historically, over long periods of time, diversified portfolios of US stock funds outperformed most bond funds.
  • Stock funds were more volatile than bond funds.
  • When you read or hear about returns for the S&P 500 Index, those returns may or may not reflect increases in value from reinvested dividends and capital gains. When reported index returns do include dividends and capital gains, you can expect similar returns for the Index and funds that track that Index.
  • Past performance is no guarantee of future performance.

Notes:

This is for educational purposes only. To learn more about the topics mentioned and if they are suitable for you, consult an appropriate professional. Tax laws can change at any time.

Any information provided in this presentation has been prepared from sources believed to be reliable, but is not guaranteed and is not a complete summary or statement of all available data necessary for making an investment decision. Any information provided is for information purposes only and does not constitute a recommendation.

Keep in mind that:
  • Past performance is no guarantee of future performance;
  • Investments involve the risk of loss of principal and earnings;
  • ETFs, mutual funds, money market funds, etc. are not guaranteed by the US Government, the FDIC, a bank or anyone else.
  • “Average annual return” evens out variations in the actual year-to-year returns.
  • ETFs, mutual funds and individual stocks and bonds fluctuate in value and there will always be times when they lose value.
  • None of the information provided is necessarily relevant to anyone’s personal situation. Circumstances differ among individuals and they should not assume that these generalizations or information apply to them.
  • Investments mentioned may not be suitable for all investors.