Market Indices

You probably hear something on the news every day about the All Ordinaries Index or the S&P/ASX 200 Index.  These major indices measure the performance of the share market as a whole.

 The All Ords and the ASX 200 track closely together.  The ASX 200 comprises the largest 200 companies.  The All Ords captures 500 or so companies, but most of the value of those 500 companies resides in the largest 200, so these indices are largely interchangeable for the purposes of normal investors.

 The All Ords is based on the share prices of all 500-odd companies which meet the requirements for inclusion in the index.  Companies are weighted into the index according to their market capitalization (meaning the total nuber of company shares issued times the market price).

 Example:  if a company has a million shares on issue and the share price is $10, the market capitalization is $10 million.

The biggest companies, such as BHP, Telstra, and all of the four big banks, each have market capitalizations of $60-$130 billion.  The Financial sector make up 47% of the ASX 200 and the Mining sector makes up 13%. In total these sectors make up around 60% of the ASX 200, so they have the biggest effect on the index.

 The purpose of the All Ordinaries Index is to give you a single figure which reflects the experience of owning all the shares in the market (weighted for capitalization.)  If the All Ords goes up or down 2%, chances are a portfolio of major shares has probably moved by about the same amount.  The price of any individual share can move in a direction opposite to the index, of course.

 More useful, but less newsworthy, is the All Ordinaries Accumulation Index.  This index assumes you own all of the shares in the All Ords, but also accounts for the dividends you would receive from these shares.  It also assumes you re-invest your dividends when you receive them.  The Accumulation Index is more directly relevant to the actual experience of real investors than the All Ords itself.

There are also lots of sub-indices.  These include, for example, indices of listed property trusts, resources companies, energy companies, and smaller companies.  The main use of these indices is that of comparing the performance of your investments to those of the relevant markets.

The All Ords and all the other indices are interesting, but don’t make too much of them.  They’re all concerned only with prices, and if you get anything at all out of this book, you’ll learn to pay less attention to prices.

The chart above tracks the All Ordinaries Index (Blue) and the All Ordinaries Accumulation Index (Red) and shows what the experience of owning the whole market would have been like over the past decades.  Because the Accumulation Index captures the value of dividends paid as well as share price changes, its progress is smoother than that of the All Ords.  It's also far more like the experience of actually owning shares. 

This chart highlights the power of yield (income) the portfolio produces. Most investors focus only on the capital gains and forget about the income. As highlighted above the income contributes to the overall return, it also smooths out he performance of your portfolio.

Taking a long term view and focusing on income works wonders