What it means
An index is a single number that summarises the performance of a basket of shares. The Nasdaq 100 was launched in 1985 and includes the 100 biggest companies on the Nasdaq exchange by market value, excluding financial companies such as banks and insurers.
Companies from outside the United States can be included if they are listed on Nasdaq. The index is weighted by market capitalisation, which is the share price multiplied by the number of shares in issue.
Larger companies therefore have a bigger effect on the index than smaller ones. The version used is modified, meaning that rules limit the influence of the very largest members so that a few firms cannot dominate completely.
Index providers review the membership regularly, usually once a year, and rebalance the weights at set intervals. A company that grows large enough can join, while one that shrinks or leaves the exchange can be removed.
This gives the index a built-in tendency to follow the winners. The Nasdaq 100 is often confused with the Nasdaq Composite, which includes almost every share listed on Nasdaq.
The Nasdaq 100 is narrower, more concentrated and excludes financials, so the two can move differently in the same week. Many exchange-traded funds and futures contracts track the index, so it is widely used by professionals and ordinary savers alike.
Funds that track it are among the largest in the world. A pension scheme or corporate treasury holding a Nasdaq 100 fund should remember that it is concentrated in a few sectors and can fall sharply when growth shares go out of favour.
In practice
Real-world examples.
Example
A retiree buys an exchange-traded fund that tracks the Nasdaq 100 for $10,000. When the index rises 8% over the year, the value of her investment rises by roughly $800 before fees. She notes that a fall of the same size would cost her the same amount.
Example
A corporate treasurer compares the performance of the company's pension fund against the Nasdaq 100 and a broader global index. She finds that the fund lagged because it held fewer technology shares. She reports the comparison to the trustees along with the risk differences.
Example
A risk manager at an asset management firm notices that his client portfolios have large holdings in several of the index's biggest members. He reduces the overlap to avoid being too concentrated in a small number of businesses. He documents the change in the firm's risk log and tells his clients which holdings overlap.
Formula
Calculation
Index level = Total adjusted market capitalisation of all members / Divisor
The divisor is a number set by the index provider and adjusted whenever companies join or leave, so the index level does not jump for reasons unrelated to market moves.
Using illustrative figures, suppose the 100 members have a total adjusted market capitalisation of $12,000,000,000 and the divisor is 600,000. The index level is $12,000,000,000 / 600,000 = 20,000.
If the total rises to $12,600,000,000 and the divisor does not change, the new level is $12,600,000,000 / 600,000 = 21,000. The percentage change is (21,000 - 20,000) / 20,000 = 5%.Case study
Seen in the real world.
Brightwater Advisers is an illustrative, fictional financial planning firm. A client asked why her fund that tracked the Nasdaq 100 had risen 30% in a year while her diversified portfolio had risen only 11%.
The adviser explained that the index was heavily weighted towards a handful of large growth companies, so the same companies that drove its gains could also produce steep falls. He showed that in a previous downturn the fund had dropped nearly twice as much as the broad market.
In this illustrative story the client kept 20% of her savings in the index fund and the rest in a mix of other assets, with a written plan to rebalance each year. The case shows that strong recent returns do not remove concentration risk, and that a long time horizon is needed for concentrated funds.
Watch out
Common mistakes.
- Thinking the Nasdaq 100 includes every company listed on Nasdaq, when it covers only the 100 largest non-financial ones.
- Assuming it is well diversified, when it is concentrated in technology and a small group of large companies.
- Confusing it with the Nasdaq Composite, which is much broader.
Questions
People also ask.
Does the Nasdaq 100 include banks?
No, financial companies are excluded.
Can foreign companies be in the index?
Yes, if they are listed on the Nasdaq exchange and meet the eligibility rules.
How can I invest in the Nasdaq 100?
Through index funds, exchange-traded funds or futures, which aim to track its performance, though each has fees and risks. Check the fund's costs and how closely it follows the index before buying.
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