Size Matters

So apparently the ASX is set to start the week higher…. What the hell does that mean?

OK get ready, cause we’re about to drop some knowledge, so you best be prepared to pick it up. Whenever the media talks about the ASX or “the market”, they are actually referring to a very specific subsection of companies which trade on the Australian stock exchange. How specific? The largest 200 specific. And that collection of companies has a name which you’ve probably heard before – the S&P/ASX200 Index or the ASX200 for short. Or the ASX for even shorter… So when they say “the ASX is set to start the week higher”, what they actually mean, is that the largest 200 companies which trade on the Australian stock exchange are likely to increase in value today.

Size Matters…
The way the Index has been created, larger companies make up a larger proportion of the Index. For example, the big 4 banks (ANZ, Westpac, NAB and the Commonwealth bank), together account for over 30% of the index’s value. Yep, that’s right, 4 companies account for over 30% of the total value  of the ASX200 Index. In fact the largest 20 companies, make up more than 65%.

So why does size matter? The purpose of an index is to get a rough representation of how the entire stock market is doing. Bigger companies, because they are bigger, have a disproportionate impact on that. The Commonwealth Bank of Australia, the largest company in Australia, is worth over 130 billion dollars and employs more than 45,000 people. If for whatever reason, it was to half in value, cutting half of its workforce along the way, it would have a pretty meaningful impact on both the stock market and the Australian economy more broadly. And for that reason, how much its worth and how its value changes over time, is disproportionately important. The same goes for the other 3 banks too.

So the ASX200 Index is made up of the largest 200 companies by value, with each company’s weighting in the index determined by its size. Like we said, bigger companies have a larger weight than small companies. Because of this too, bigger companies get more airtime on the 6pm news. Companies like the banks, BHP, RIO and Fortsecue (Australia’s biggest mining companies), Telstra and Woolworths. These companies alone are about 50% of the index by value, so how they are doing is pretty important in understanding how the ASX200 and the Australian stock market more broadly is doing.

Investing in the ASX200
The S&P/ASX200 Index is something which you, as an investor can get access to extremely cheaply. It’s actually a very “easy” thing to do. If you wanted to match the returns of the ASX200 Index, all you would need to know is how to split your investment across each of the 200 stocks in the index. Once you know that, you’re set.

Because it’s such a “simple” thing to do, there exist a number of different companies (or fund managers) who will do this for you on your behalf. Their entire business is designed to replicate the ASX200 Index perfectly. They are called passive managers and they are the cheapest possible way for you to invest in the stock market. And if you don’t know what you are doing, they are the only way you should be thinking of investing…. But more on that another time.

 

Got a finance question, but short on time? Send us an email at daily@5minute.finance and we’ll help you out

 

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Categories: Investing

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