What are indexes?

Investopedia defines indexes as “a method to track the performance of a group of assets in a standardized way. Indexes typically measure the performance of a basket of securities intended to replicate a certain area of the market.” Basically, they’re a large group of stocks clumped together. Because they’re clumped together, their growth combines, and you can tell how that whole group of stocks is–generally–doing. As you can guess, this is way more efficient than just looking at each individual stock. To find out more about the nitty-gritty, you can see the full article here. 

Since it’s so efficient, analysts and average investors alike have taken a liking to them. I mean, saving time and making life easier… what’s not to like? They can also convey knowledge about industries you’re thinking of buying stocks from. This is massive because it lets you know if the company you’ve been eyeing for a while is even in a good industry. And let’s be honest, there’s no point in buying a company that’s going to sink in a year or two. 

Examples of indexes showing growth between businesses are extremely prevalent wherever you look. Indexes showing doggie-bag manufacturers aren’t likely to even come close with indexes tracking modern obsessions like electric vehicles or trendy white paint manufacturers. Indexes also show what type of businesses are growing and failing and help you be guided away from pitfalls, which are very, very likely to happen without proper research of a company’s background. 

Why indexes are important

Looking at indexes can be a major help in your research for a new investment. Every index has stocks from a specific industry it’s geared to and made up of. Another example of an index fund that you might have heard of is the Nasdaq (the main tech-stock index) which covers major giants like Google, Microsoft, and Apple. This index has historically outperformed many individual stocks and is more than likely to be growing in the future. 

Apart from showing how different companies in the same industry, indexes also function for markets. If SUNIDX (the solar power index), for example, is up, that means the general solar power market is up as well. When looking at the history of growth with these indexes, it also shows the growth of that specific market, which shows if the stock you want to invest in is in a profitable business.

Indexes are really important to understand for any aspiring financially free human. Whether young, old, tall, or short, indexes are a major part of the language with stock investing. When looking at popular news articles and videos online, you’ll often find a graph of an index in the background, as news anchors quickly explain the current events in the markets. You’ll also be familiar with the groans of adults talking about how the “market” is down; by this, they most likely mean the S&P 500 (which stands for Standard and Poor’s 500) or another large index. By the way, the prefix of “Standard and Poor” is just the name of the company that made the S&P 500 and isn’t really that important compared to the 500 part. The number that follows a lot of indexes affects how they grow and act in the market; generally, with American indexes, the number stands for the top companies in whatever market it’s covering.

Other well-known indexes are the Russel 2000 (top 2000 companies), Dow (top 50 companies), and the Nasdaq (tech companies). S&P 500 tracks the top 500 companies in America, so it’s often regarded as the best way to see America’s stock market condition in the present. But not only can you extract the temperature of the market daily with indexes, but you can also invest in them! 

The benefits of investing in index funds

Investing in large companies all at the same time provides big benefits. Since the vast majority of these companies have an amazing record of growth and are often regarded as the “the ones that got away .”Though their massive growth periods are over, companies like these are still essential to invest in because they are usually industry leaders and are the first to meet market demand. Gaining these all in one basket of awesome stocks set for growth shows why index ETFs are essential to have in the beginner investor’s portfolio.

But out of the hundreds, maybe thousands of ETFs that exist, which one should you invest in? Look no further than the S&P 500. We’ve mentioned this index previously when talking about the information Indexes contain, but this index still stands on top! The S&P 500 has had an average of 10% annual returns since the 1920s, a return that has proven tricky to beat. The LA Times said, “More than 57% of all U.S. domestic stock funds underperformed their benchmarks in 2020…In some categories, the record was even worse: About 60% of all…mutual funds failed to match the S&P 500 index, and more than 80% of…mutual funds fell short of the S&P MidCap 400 index.”

Historically, trying to beat the S&P 500 (or similar indexes) in terms of growth has proven to be pretty futile. And if you can’t beat them, join them! It just goes to show how Indexes are great beginner investments for their awesome growth that even groups of professional analysts can’t beat! But the funds that these professionals manage (called mutual funds) that do manage to beat/track the market often cost large fees, which take away from any money the investments have made. Not to mention the initial investment requirement that’s usually in the thousands.

So is that it? Are teens forever banished from the glory of these indexes, forced to invest in these costly funds? Ramsey (not the one you’re thinking of) of the financial world and his company Ramsey solutions, an extremely well-regarded company in terms of helping with early retirement, further complained about the harmful fees on these funds and their effect on dampening early retirement. But suddenly, a light descends from the heavens, a scroll drops into your hands, and it reads: “ETFs.”

What are ETFs?

Briefly explained, ETFs stand for Exchange-traded-funds. Despite the intimidating name, they are quite simple to purchase and provide tons of benefits. They get rid of much of the risk when investing in a single stock. Instead of being at the mercy of the market with a single stock, riding the tall highs and devastating lows, ETFs provide stability. They include all of the growth of the ‘holdings’ (names for stocks inside an ETF) and combine them to make for a much more stable value appreciation.

If you’ve been searching for any “How-Tos” about stocks, you’ve likely heard about ‘diversification.’ This just means investing in different types of stocks (and even other assets), so that if a single market completely collapses, overnight your entire fortune isn’t destroyed. It also sweetens the deal by almost promising a profit if you invest in industries not affected by each other. So if one goes down, the other can stay afloat and protect your money. ETFs provide almost instant diversification since they are made of a group of stocks! 

To top it all off, most of the time, they are drastically cheaper. ETFs have a management fee called an expense ratio. ETFs fees, however, are generally around 0.50% of a fee, compared to a mutual fund average of 1.40% of a fee. This is due to ETFs being less managed than a mutual fund which is constantly experiencing changes. Because ETFs are similar in Indexes with their ability to contain multiple companies, they can also contain the same stocks that indexes do, essentially making it so you can invest in an Index! It’s a proven way to essentially capture the returns that indexes show in certain markets and is what many professionals mean when they say: “Invest in the *random* index”. Popular ETFs include SPDR (tracking the S&P 500), QQQ (tracking the Nasdaq index), and many more included here. 

The takeaways:

So, whenever you hear about the market going up or down, how “tech” isn’t doing well today, or maybe the complaints of your peers in “needing more diversification” within their portfolio, you can rest easy knowing you have some Index ETFs in your back pocket. Not to mention how their growth is nothing to scoff at. So now you know what indexes are and how to invest in them, congrats! Indexes and their ETFs are cornerstones to any good portfolio and great for teens aspiring to be financially free!