What is a Market-Cap Based Indices Stock Index?

What are Market-Cap Based Indices

Market cap-based indices are stock indexes that are designed to provide exposure to small capitalization stocks. These indexes are constructed using four standard techniques: quantitative screening, fundamental weighting, liquidity screens, and market-value weighting. The Small Cap Index measures the performance of small-capitalization stocks in the broad equity markets through generally accepted standards for measuring and monitoring them. Small-capitalization stocks are those companies with market values of less than $2 billion. The Small Cap Index is a market cap-weighted index that is designed to track the performance of the small-capitalization segment of the U.S. equity market. The stocks in the index are selected by a rules-based methodology that focuses on market values. This index includes stocks of all industry sectors. The objective is to provide a diversified equity exposure representing a substantial portion of the U.S. equity market, including small capitalization stocks, with the potential for above-average returns. The Small Cap Index is owned and managed by S&P Dow Jones Indices.

Investing in a Market-Cap Based Indices

When you invest in market cap-based indices, you invest in a basket of stocks that make up an equity index. When you buy or sell the underlying index fund, you are therefore buying or selling a basket of stocks. This can be beneficial because you are not picking individual stocks to invest in you are buying a piece of the market. When you invest in an equity index fund, you own a piece of each of the companies in the index. So, if you invest in the S&P 500 index fund, you own a piece of each of the 500 companies in that index. This can also be a disadvantage because you are not picking individual stocks to invest in you are buying a piece of the entire market. This is what can cause you to lose money in a market downturn.

Advantages of Market-Cap-Based Indices

- Low-cost - Small-cap indexes tend to have a lower cost of ownership than the large-cap indexes. This is because there are fewer stocks in small-cap indexes and they are generally less liquid than large-cap indexes.

- Tax efficiency - Small-cap indices are more tax efficient than large-cap indices because of the lower turnover rates.

- Diversification - Small-cap indices are more diversified than large-cap indices because there are generally fewer stocks in the index.

- Simplicity - Small-cap indices are simpler to understand and trade than large-cap indices.

- Consistency - Small-cap indices hold a consistent number of stocks every year, unlike large-cap indices which can change each year.

Disadvantages of Market-Cap-Based Indices

- Sector Concentration - Small cap indices are concentrated in a few industries because of their market capitalization-driven selection methodology.

- Small Company Risk - Small cap indices are subject to the risk that small companies do not survive and are bankrupt.

- Volatility - Small-cap indices are more volatile than large-cap indices because of their higher risk.

- Turnover - Small cap indices have high turnover because the stocks are more actively traded.

- Tax Inefficiency - Small-cap indices are more tax inefficient than large-cap indices because of their higher turnover rates.

- Lack of Diversification - Small-cap indices are less diversified than large-cap indices because there are fewer stocks in the index.

- Complexity - Small-cap indices are more complex to understand and trade than large-cap indices.

- Lack of Authority - Small-cap indices are not as widely followed as large-cap indices.

Conclusion

The stock market is where investors come together to buy and sell shares of publicly traded companies. The market is the economy’s primary channel for the creation and distribution of wealth. Anyone can invest in the stock market, either directly or through a mutual fund or ETF. The stock market is composed of three major segments: large-cap stocks, mid-cap stocks, and small-cap stocks. Small-cap stocks are those companies with market values of less than $2 billion. An equity index is a listing of the value of specific stocks relating to a particular market or sector.