Investing Explained: How Does an Index Work?

Indices that are weighted towards the biggest companies have many benefits, but they are not an ideal fit for all markets and strategies

Daniel Sotiroff 25 January, 2019 | 2:37PM

Apple

Benjamin Graham famously wrote in The Intelligent Investor: “In the short run, the market is a voting machine but in the long run, it is a weighing machine.”

Indices that are weighted towards the biggest companies have their benefits. Funds that track market capitalisation-weighted indices cut back on turnover and the related trading costs. They also grasp the market’s collective opinion of each stock’s relative value, a consensus that has historically proven tough to beat. But using a cap-weighted approach with certain markets or strategies is not always the best fit.

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About Author

Daniel Sotiroff  is an analyst, passive strategies research, for Morningstar

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