In most parts of life, being average isn’t worth bragging about. Yet in the stock market, being average is pretty cool — and not in the way people tell you to raise your self-esteem.
The stock market is full of things called indexes (or indices). An index measures the weighted average of a market sector or an entire market. For instance, if you want to see how the video game industry is doing on average, you only need to look at the EEFundVideoGame Tech Index. If that index is up, stocks in the video game industry are up as a whole during a given day, week, or month. If that index is down, then the industry might have a bit of a hiccup.
Finding out an index’s average gives you an approximate and average view of hundreds of stocks without looking at all of them individually. It’s also a baseline for how well certain stocks or your portfolio should perform. If your stock or fund consistently performs below average over months or years, it might not be worth keeping.
What’s the stock market average?
To understand the market average, you must understand the S&P 500. This stock market index is used to track the entire American stock market. It uses the weighted average of 500 different American companies in a variety of different sectors to determine the index’s value. If the index is up, the stock market is up. If the index is down, the stock market is down.
Indexes historically increase over time. When the S&P 500 increases (or decreases) during a certain period, investors often compare stocks and funds to these gains and losses. It is generally believed that all individual stocks and funds should make at least make the same movements as the S&P. So, if the S&P 500 is up by 3% in three months, a “healthy” stock should make at least that, if not more.
What’s “beating” the average?
Most investors don’t want their individual stocks and funds to be average. They want them to be way above average. Many stocks outperform the S&P 500 on a regular basis, seeing absurd gains in a single year as market indexes slowly chug along. Therefore, these stocks beat the average by performing better than the market’s current growth.
This isn’t always the case, of course. Many securities perform lower-than-average, though this doesn’t mean these stocks and funds are dead in the water. A stock could have a bad quarter or year and pick back up at a later date. If this stock continuously performs below the market average for a longer period of time, then you might have something worth worrying about.
Why is average good?
If the stock market is up and you’re making gains based on the average, then you’re making a heck of a lot more than if you put your money in a mattress. You’re also likely making significantly more than your savings account. By investing in low-cost, low-risk exchange-traded funds, like $SPY or $VOO, your money will move at the same pace as the S&P 500. If the S&P increases by 1%, your investment will increase by 1%.
Having an investment in an ETF that follows the market average is an easy way to potentially protect (or hedge) against other riskier investments. If you have a stock that’s performing rather poorly but the market average is up, your ETFs’ gains could effectively cancel out your losses. You won’t make as many gains at the moment, but you (hopefully) won’t lose money in the process.
Could you try to beat the average? Sure, but doing so would involve taking risks and buying stocks that could fall below average. Instead of doing that, many investors believe that the first $10,000 you invest should be spent following the S&P 500. To learn how to do just that, read our guide here.