What is an index and how is it used?
An index is the combined value of a group of securities that’s used as a benchmark by investors to measure the performance of their own investment portfolios. An index works on the assumption that a sample of securities will replicate the whole market for those securities.
Examples of indexes include the NZX-50 – which replicates the performance of the New Zealand Stock Exchange’s 50 largest stocks, and the Dow Jones Industrial Average (DJIA) – which replicates the performance of 30 major stocks traded on the New York Stock Exchange and the Nasdaq.
Index tracking, also known as ‘passive management’, is an investment strategy that tracks the performance of an index. It involves investing in most or all of the securities within an index with the aim of maximising diversification, reducing risk and volatility, and improving returns over the long term.
Index tracking is generally less risky than the ‘active’ way of investing (where investors actively buy and sell stocks) and, because of its passive nature, the management fees for a passively-managed fund can also be lower.
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