When I was a kid listening to the radio in the car, I used to hear reports of a certain Straits Times Index (STI) and its performance. My immediate thought was that it was really strange that a newspaper had an index that went up and down. I wasn’t exactly wrong though, because the STI is related in the sense that one of its creators was Singapore Press Holdings (SPH), which as you might know, owns the Straits Times publication.
Since then, I’ve obviously learnt more about the STI, but what exactly is an index anyway? Technically speaking, an index is a measure of the changes in a group of stocks that represent a portion of the overall market. Perhaps the best known index in the world, and incidentally the first index ever created, is the Dow Jones Index, which comprises 30 of the largest and most influential companies in the US. In the case of the STI, this group is made up of the top 30 companies listed on the Singapore Exchange (SGX).
Different indices can comprise of different stocks, and because it’s just a group of stocks, technically anyone can create an index. Some of them might be industry-specific, like a technology index, and many others are country-specific, comprising stocks listed on a particular country’s exchange. But how can you get exposure to indices? And why are they something you should consider? Let’s use the STI as an example.
How does the STI move?
The STI uses a capitalization-weighted methodology to calculate performance. What that means is it uses the market value of each stock of the STI and weighs that against that stock’s percentage of market share.
So let’s say for instance that Stock A has a weightage of 15% versus Stock B’s weightage of 2% (with both stocks being on the same index , of course). Changes to the value of Stock A will have a much bigger impact on the overall index than a similar change to the value of Stock B, because of its weightage.
What are the pros and cons of indices?
One of the biggest selling points of indices, especially ones that have been created by reputable companies such as Dow Jones & Company, or from a local case, SPH, is that the constituents of the index are strong performing companies.
In a place like Singapore, where people are constantly found complaining about the “high cost of living”, investing in something like the STI gives you an opportunity to benefit from the good performance of the top companies in Singapore so even if personal costs go up, you know that in an indirect way, you’re actually benefitting from it.
One of the key considerations for getting exposure to indices, however, is also the fact that you will have to be able to deal with market fluctuations, which might not be for everyone. Having a long-term view on investing in indices can help you to ride out the ups and downs of the market, but there are other ways in which you can manage your risk as well.
Finding a good platform that makes managing your portfolio easy is extremely important because, following on the previous point, you might not be the sort that wants to deal with daily fluctuations in the market.
Platforms like IG provide you access to trade CFDs on global indices. The IG platform comes with some very important tools that will help with risk management, such as Guaranteed Stops that help you to adjust the level of risk you are comfortable to take on, and you don’t get charged unless that threshold is hit. They also enable you to trade global markets in SGD, so you don’t have to worry about currency exposure on top of dealing with market fluctuations. Certainly a much better solution than a regular visit to a heart specialist to make sure your blood pressure hasn’t shot through the roof.
It’s not surprising why many investing experts, including Warren Buffett, advocate getting exposure to indices over actively managed funds. While it doesn’t have to be the only investment in your portfolio, it’s certainly a good way to start out
While you might want to do a bit more homework about the markets or industries that you are investing in, a good platform won’t just give you that information, but also give you the tools that will help you to manage your investments better.
This article was sponsored by IG, the world’s No.1 CFD provider (by revenue excluding FX, 2016). All views expressed in the article are the independent opinion of MoneySmart.
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