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A stock index is a statistical indicator of changes in the value of a group of stocks. They are used as the bases for investment vehicles, as benchmarks of investor skill and as research tools. Practitioners believe they know what an index is once it’s been described by its weighting scheme, rebalance frequency and inclusion rules. Even so, a number of index myths abound. Some myths make for interesting trivia, while others can affect the validity of research or influence investment decisions. Below is a collection of index myths believed by novices and experts alike.
Myth 1: The Dow Jones Industrial Average Was The First Stock Index
The Dow Jones Industrial Average (DJIA) has been calculated daily since its 12-stock inception on May 26, 1896. Although it is known (incorrectly) as the oldest continuing market index, it was not even Charles Henry Dow’s first stock index. Twelve years earlier, Mr. Dow’s initial stock average, containing 11 stocks (nine of which were railroad issues) appeared in Customer’s Afternoon Letter, a daily two-page financial news bulletin that was the precursor of the Wall Street Journal; today that average is known as the Dow Jones Transportation Average.1 As for the DJIA, on Oct. 4, 1916, its number of components increased to 20, and then to 30 twelve years later, where its count remains today.
Myth 2: The S&P 500 Includes The 500 Largest Stocks
The S&P 500 was originally designed as a measure of the stock market built from the industry level up. The S&P Committee selects “leading” companies while considering profitability, liquidity and industry representation. In general, this meant larger companies, but this was not a requirement. Major industry and sector numerical constraints such as 400 industrials, 40 utilities, 40 financials and 20 transportation companies existed until 1988, and the S&P 500 Index did not contain 500 stocks until March 4, 1957.2
With the creation of the S&P MidCap 400 (June 19, 1991) and the S&P SmallCap 600 (Oct. 17, 1994), the S&P 500 implicitly added the goal of being a large-cap index. Using the Wilshire 5000 membership for size comparisons, Figure 1 shows that during the last 20 years, the number of S&P 500 companies not in the top 500, 750 and 1,000 by market-capitalization rank has decreased.
Myth 3: The Wilshire 5000 Index Has Exactly 5,000 Stocks
This isn’t as bad as asking who is buried in Grant’s tomb, or how many stocks are in the Standard & Poor’s 500, because unlike S&P’s objective of maintaining a membership count of exactly 500 stocks, the Wilshire 5000 Total Market Index is not an index of 5,000 stocks. Since its inception, the Wilshire 5000 was designed to measure the performance of the total U.S. equity market; therefore, there are no minimum or maximum limits to its membership. During its summer 1974 development, the soon to be named Wilshire 5000 Equity Index had just shy of 5,000 issues—thus the number 5000 was made part of the name to convey the breadth of the index’s coverage. The Wilshire 5000 membership count has ranged from 3,069 on Feb. 28, 1971 to 7,562 on July 31, 1998. The membership count on December 31, 2009 was 4,041.
Myth 4: The Russell 3000 Covers 98% Of The Market
The common marketing line for broad market index coverage is 98 percent. For years, the Frank Russell Company has been making the claim that the Russell 3000 Index covers approximately 98 percent of the market. Interestingly, Wilshire Associates doesn’t make the claim that the Wilshire 5000 covers 100 percent of the market, just that it is the most pure and complete representation of the total U.S. market. However, according to Figure 2, the Russell 3000 continues to have less than 98 percent coverage 3 of the Wilshire 5000 and represented as little as 92 percent of the Wilshire 5000 in the late ’80s and less than 96 percent as recently as 2006.
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