When people say “The market is up today,” they’re typically referring to a market index. What exactly is this, and what does its performance tell us (and not tell us) about the economy as a whole? This article discusses this very topic.

What is a market index?

A market index is a tool (essentially a “shortcut”) that helps us understand how the stock market is doing without the need to look at every single stock, kind of like checking the score of a sports game to see if your team is up or down without knowing each and every play. Economists, news outlets, and investors use market indices to get a quick idea of how the market is doing overall and make decisions accordingly. Here’s how it works…

A market index tracks the performance of a group of stocks chosen because they represent a specific slice of the market. The S&P 500, for example, looks at 500 of the biggest companies in the U.S. Other popular indices include the Dow Jones Industrial Average (the Dow), which follows 30 large companies, and the more tech-focused Nasdaq Composite.

How do market indices work?

While all market indices follow the price of a group of selected stocks, the weight of each company differs based on the type of index. In other words, index stocks aren’t always treated equally, with the amount of influence dependent on how the index is built. While the methodology of each index is unique, three primary strategies are as follows:

Price-weighted indices (e.g., the Dow) give more weight to stocks with higher share prices, meaning a company with a $300 stock price will impact the index more than a company with a $100 stock price (even if the smaller company is actually worth more overall), for example.
Market-cap-weighted indices (e.g., the S&P 500) do things differently and give more weight to companies based on their total market value (AKA market capitalization). Bigger companies, like Apple or Microsoft, have a larger effect on the index than smaller ones.
Equal-weighted indices treat all companies the same, no matter their size or stock price, meaning they have the same amount of influence (giving smaller companies more of a voice in how the index moves).

Why does the weighting of a company matter? Because a market index is like a recipe, each stock representing a different ingredient. Even if you have two recipes with the same exact ingredients, different proportions of each one will produce two different results. This leads us to an important distinction: a market index and the overall economy are not one in the same, the former simply providing a snapshot of the market.

Market index vs the economy

When you hear “the market is up,” it’s tempting to assume the whole economy must be thriving. When it’s down? Panic. While a stock market index is indeed a useful indicator, a single number is limited with respect to what it can tell us.

For example, the S&P 500 index reflects the performance of large, publicly traded companies—not small businesses, consumer wallets, nor the job market. If these large companies are doing well (or are expected to), the index can rise even during a recession or when unemployment is high. Likewise, the market can drop even when day-to-day metrics (e.g., consumer spending and the job market) remain stable. Factors such as interest rate changes, inflation projections, or a gloomy earnings forecast can send an index down even if nothing feels particularly “off” in the real world.

Additionally, index weightings mean that a few massive companies can have an outsized impact. For example, the four largest companies in the S&P 500 (Apple, Amazon, Nvidia, and Amazon) currently account for almost 24% of the index (as of September 1, 2025); the S&P 500 can thus have a negative day due to the performance of a handful of larger companies, even if most companies within the index see positive performance.

That’s not to say such weighting is inaccurate, as giving more weight to larger companies is often a practical way to represent where most investor money is going. These companies tend to be stable, well-established, and widely held by both individual investors and retirement plans.

The bottom line? Indices are useful and efficient tools when used right, which brings us to our next section.

How investors use market indices

Benchmarking is one of the most important market index applications. Let’s say you invest in a mutual fund that focuses on large U.S. companies and want to know how your investment is doing. In this case, you’d compare its performance to a relevant index such as the S&P 500. If your fund is in line with or eclipsing the index, that’s a good sign. Consistently lagging behind? It’s perhaps time to reconsider your strategy.

Indices also help investors understand market trends. For example, a glance at the Nasdaq Composite can tell you if technology stocks are having a strong year, while the Russell 2000—which tracks smaller U.S. businesses—gives insight into the momentum of small companies, specifically. Each index shines a light on a different corner of the market.

One final major application is index investing; rather than selecting individual stocks, many investors choose to invest in funds that simply follow an index (aptly referred to as “index funds”).

How to invest in index funds

If you’re ready to start investing in index funds, the first thing to know is this: you can’t invest directly in a market index like the S&P 500 or the Nasdaq as these are just measurements, meaning they don’t actually own anything. That being said, you can invest in a fund that’s built to closely track one of them via two options: mutual funds and ETFs, both designed to copy the index by holding the same stocks in the same proportions.

As an ETF index fund is designed to match—not beat—a specific market index, it simply invests in all (or most) of the companies in that index rather than pick and choose individual stocks. In the absence of a team of analysts who try to outsmart the market, index funds are cheaper to run and thus typically associated with lower fees than mutual funds; and since they’re broadly diversified, investing in them is often less risky than betting on a few hot stocks.

Mutual funds are the other option at your disposal here, which take shape as active management and thus strive to not only match the market but in fact outperform it. While this may sound great in theory, it often comes with a higher cost than ETFs.

So, which is the better investment option between an ETF and a mutual fund? ? There’s no one-size-fits-all answer; while ETFs are great for long-term, hands-off investors who want low fees, reliable performance, and a simple way to invest, actively managed mutual funds might appeal to investors willing to pay more in the hopes of higher returns and who believe in the skill of a particular manager. Many investors use a mix of both depending on their goals, risk tolerance, and investment style, which is yet another option.

Investing in index funds, step by step

Want to invest in index funds? The process plays out as follows…

Step 1: Choose your index

First, decide which part of the market you want to track. Want exposure to big U.S. companies? Interested in tech-heavy stocks? Seeking a mix of small, medium, and large companies? No matter what you’re looking for, there’s likely an index fund that tracks it (and you can also invest in multiple of course).

Step 2: Select an ETF or mutual fund (or both)

Are you interested in active or passive management? Use this to steer your decision, choosing a mutual fund if you want active management that aims to outperform the benchmark or an ETF if you prefer lower fees.

Step 3: Choose a fund that tracks your desired index

Next, look for an mutual fund or ETF that follows your chosen index. Some of the biggest names in the game include Vanguard, Fidelity, Schwab, and BlackRock (iShares). Many offer very similar products, in which case you’ll need to compare options. One metric to consider is the expense ratio, meaning all costs associated with the fund; a lower expense ratio means a less expensive fund

Step 4: Open an investment account

You’ll need an account with a brokerage firm or investment platform. a brokerage account (for general investing) or a retirement account such as an IRA or 401(k) (for tax-advantaged long-term saving). Most brokerages make it easy to open an account online and begin investing with just a few dollars.

Step 5: Buy the fund

Once your account is set up, search for the fund by its ticker symbol (a short code that identifies it). Enter how much you want to invest, and you’re in!

Step 6: Stay consistent

Index investing is not a get-rich-quick scheme. The goal is time in the market, not timing the market; in other words, rather than constantly buy and sell you should simply add to your investment on a regular basis if you can.

What about international markets?

Want to diversify beyond the U.S.? That’s good news, as the world of investing is much bigger than just one country; others have their own stock markets and use market indices as well to track how they’re doing. Here are a few key international indices to familiarize yourself with if you’d like to explore global investing or simply want to understand the environment beyond U.S. borders.

FTSE 100 (United Kingdom)

Pronounced “footsie,” the FTSE 100 tracks the 100 largest companies listed on the London Stock Exchange and includes global brands such as Unilever, Shell, and HSBC. Many of these companies do business around the world, so this index often reflects more than just the U.K. economy and gives a glimpse into global trade, energy, and finance.

Nikkei 225 (Japan)

One of Japan’s oldest and most-watched indices, the Nikkei 225 tracks (yes) 225 of the biggest and most actively traded companies on the Tokyo Stock Exchange including Toyota, Sony, and Nintendo. Since Japan is one of the largest economies in the world, the Nikkei gives insight into Asia’s market trends and the global tech and auto industries.

DAX (Germany)

The DAX follows 40 blue-chip companies on the Frankfurt Stock Exchange including BMW, Siemens, and SAP and is often used as a barometer for Eurozone economic health. As Germany is a manufacturing powerhouse, exports and industrial performance often influence this index.

CAC 40 (France)

The CAC 40 tracks 40 large companies listed on the Euronext Paris exchange and includes L’Oréal, Airbus, and LVMH (which owns many luxury brands). It gives a glimpse into European consumer trends, fashion, aerospace, and more.

MSCI Emerging Markets Index

Unlike the others, this index doesn’t track just one country and in fact includes companies from over 20 developing economies such as Brazil, India, China, and South Africa. It’s widely used by investors who want to tap into the growth potential of fast-changing regions that aren’t as established as the U.S. or Europe.

So, why do international indices matter? Keeping an eye on them helps investors understand global trends, spot new opportunities, and diversify their portfolios. Tying all your money to U.S. markets means potentially missing out on the full picture and possibly growth happening elsewhere in the world.

The takeaway

Individual investors and professionals alike can understand how market indices work to ultimately make smarter financial decisions and enjoy more context while evaluating portfolio returns. As with any financial metric, it's important to understand what an index represents (and what it doesn’t) to maximize its potential within your investment strategy.

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What is a Market Index?