A Quick Talk About Stock Market Indices

Today I decided to talk to you about stock market indices. We have just returned from our walk outside, and somehow Luca's little face in the stroller was asking me to explain exactly this to him. Laura, today you spent 40 euros of your own money to buy yourself a children's camera. You were very happy to pay with your card and just as sad initially when you found out that the money you spend from your card disappears forever. It would be so simple, my dear, if the money we spend from our cards never disappeared, and both your mother and I would love that enormously. Where you still need to work, however, is on patience. You have to learn to be patient and wait to play with your new toy until after you have changed your clothes. You have to learn to be patient because simply saying that you are hungry will not make food fly quickly towards you, and when your plate is too hot, the solution is to be patient and not to keep bothering mommy to blow on your food.

While you are burning yourself with hot food, Luca is arguing with a ball in his play area: "Aguugaaa arhga guaaa! eeeee....eeeee....eeeee" I think the ball is winning, judging by the sounds he is making. I have just transferred your allowance for this week into the bank account, but as I promised you, Laura, you will receive nothing tomorrow because you have not behaved well. Luca will receive your share of the allowance too. When we were out for our walk, the little koala bear was sitting upright in his stroller, watching the people passing by. Colmar is slowly dressing itself in Christmas clothes, and the first decorations have started to appear. When Luca was smiling at the people around him and you were urging us to walk faster so that you could get to play with your new toy, part of me was smiling. You have no idea what military discipline awaits you when you grow older. We are trying to find the optimal balance between putting pressure on you to develop properly in society and allowing you to be children, to play, cry or scream. As I write these lines, mommy is explaining to you for the tenth time that you are not getting anything else to eat and that you have to wait until dinner is ready.

In my desire to help you both understand the world, I realized that perhaps I should tell you a few things about how you can invest your money. Today I want to talk to you about stock market indices, as I already started to do. I would love it if, by the time you read these lines, you already knew everything about this, and even more than I do. I would love for you to gather as much information as possible over the coming years, but the chances are small at the moment. Luca is still arguing with the ball while crying, and Laura, you have locked yourself in your room and started shouting for us. I am surprised that you have not managed to detonate a nuclear bomb yet and that I can still hear mommy pretending to eat your tummy and making you laugh.

Let's talk a little about the stock market. As you already know, shares are sold on the stock market, shares that represent parts of a company. If a company has only one share, buying it means that you own 100% of that company. If the same company has one million shares, then buying one gives you only 0.0001% of that company. And the price at which these shares are sold depends mainly on the number of shares and the total value of the company. But what do you do if you want to follow several companies, or several markets or continents, as well as several sectors? To complicate the situation even further, certain companies are listed only on certain stock exchanges. In general, what we find listed on the New York Stock Exchange differs from what we find on the Frankfurt or Paris stock exchanges. Although there are certain global instruments that allow you to invest across borders and continents, most companies are listed locally, on the stock exchanges closest to them.

A stock market index is a grouping of companies and shares that combines the evolution of the prices of the companies included in the index into a single number based on a mathematical formula. You will be surprised to learn that there are many indices. Here are just a few examples. S&P 500 – tracks the 500 largest companies in America. STOXX Europe 600 – tracks the 600 largest companies in Europe. DAX – tracks the most important companies listed on the German stock exchange. Nikkei 225 – tracks companies listed on the Tokyo Stock Exchange. Besides these, there are numerous other indices, such as CAC 40 for France, Nifty 50 for India, SMI for Switzerland, and so on. There are also indices that track only companies from certain sectors.

Your question now should be who creates these indices and why? "Auaauaaauaua gaaagaaaa auaauuaa!" Luca, daddy, I don't think that's an index you can invest in. Indices are created by specialized companies called index providers, and they establish the criteria according to which companies enter and leave the index and in what proportion each company is represented. The general trend is for large companies to hold a larger share of the index and smaller companies to have smaller weights. This can lead to the situation we have today, where the S&P 500 contains 500 companies, but approximately 30% of the index is actually made up of few large IT and AI companies. In other words, an investment in the S&P 500 means that we invest 30% in AI companies, and a collapse of the market would bring with it a significant loss of our capital. It is important to understand the structure of the index in which you invest, the individual weight of each company, and the criteria for removal from the index.

If we analyze the STOXX Europe 600, we can see that the index includes European countries in different percentages. So if, for example, we are betting on the development of Portugal's economy in the coming years, the STOXX 600 would be a poor choice because Portugal is represented only to a minimal extent in this index.

Buying stock market indices, however, does not give us a share of the respective company because, in the process, we have not bought the shares directly. Certain funds buy the shares in the name of the fund, and we buy shares in these ETFs. Although we gain exposure, the shares of the companies are not our property but the property of the fund to which they belong. By buying a broad fund in this way, however, we reduce the relative risk because we are not betting on a single company. Another important characteristic is the ability to be self-cleansing. Just as certain companies can enter different stock market indices, if they underperform, they can also be removed. At that moment, the fund will sell their shares and buy shares in another company that meets the criteria again. In other words, when you buy a broad index, you are actually betting that the stock market will go up. With certain limitations, this is almost always true on one condition: that you give it enough time. Any crash is difficult to spot from 10 or 20 years away when analyzing the chart on a higher timeframe. The current growth rate of the market is approximately 10% per year. So an investor can expect their assets to double every 8 to 10 years.

Today's lesson is very simple. Besides the shares listed on the stock exchange, you can also buy stock market indices. These are actually the same shares bought by investment funds, and you gain exposure by buying shares in the ETFs of these funds. One of the recent examples of ETFs introduced is BlackRock's Bitcoin ETF. Anyone who does not want to buy and store Bitcoin themselves and risk losing it can buy their Bitcoin ETF. The important advantage is that you do not have to be Warren Buffett to identify individual companies, but you can invest in the entire market as a whole, and the existing indices allow us to invest in almost any country, continent or sector. Besides that, even if there are companies in the economy that fail, they will be replaced by others, and the impact on the fund is minimal.

Meanwhile, Luca, you have fallen asleep curled up at the breast, and Laura, you are almost crawling on the floor from hunger, shouting that you want to eat something other than what has been prepared. I think, my dear, that this is not the right moment to talk to you about stock market indices. Go wash your hands and come to the table.