How an Index Is Built
When people say 'the S&P 500 rose,' who exactly calculates that number, and how? Even a single index hides an intricate set of rules for inclusion, weighting, and periodic reconstitution.
The Three Decisions That Build an Index
A stock index summarizes the prices of many stocks into a single number. When you design an index, you broadly have to decide three things.
(1) Inclusion rules: which stocks go in. (e.g., which country, what size, which sector)
(2) Weighting method: how much weight each stock gets.
(3) Rebalancing / periodic reconstitution: when to revise the constituents and weights again.
These three determine the character of the index. Even in the same market, different rules produce a completely different index.
The Weighting Method Changes the Character
There are broadly three weighting methods.
Market-cap weighting: the bigger the company (market capitalization), the larger the weight. Most flagship indices, such as the S&P 500 and KOSPI, use this method. The moves of large companies dominate the index.
Price weighting: stocks with higher share prices get larger weights. The Dow Jones 30 and Japan's Nikkei 225 are representative. The basis is not company size but 'price per share,' which is somewhat counterintuitive.
Equal weighting: every stock gets the same weight. Regardless of size, each stock gets one vote.
It is not that one method is 'correct'; the choice differs depending on what you are trying to represent.
Free Float and Periodic Reconstitution
These days, major market-cap-weighted indices reflect 'free float.' Instead of total shares outstanding, they compute weights using only the 'tradable shares' — excluding shares that are not actually traded in the market, such as those held by major shareholders, treasury stock, or the government. This is to better reflect the size you can actually invest in.
Also, an index is not fixed. It periodically adds and removes constituents in a periodic reconstitution (rebalancing). For example, the KOSPI 200 is revised twice a year (June and December) by the Korea Exchange.
Free-float adjustment is covered in more detail in the following article, 'Float-Adjusted Index.'
How Do the S&P 500 and KOSPI Differ
The inclusion methods of these two flagship indices are interestingly different.
S&P 500: an 'Index Committee' selects the stocks. There are requirements — being a U.S. company, sufficient size and liquidity, recent positive earnings — but the final judgment involves the committee's discretion to make the index represent the U.S. economy. This contrasts with the purely rule-based Russell indices.
KOSPI: it includes all stocks listed on the Korea Exchange's KOSPI market, computed by free-float market-cap weighting. Its base point is set at 100 on January 4, 1980. Unlike a separate 'selection committee' choosing stocks, it captures the entire market.
So even among 'flagship indices,' the rules for building them vary widely.
The S&P 500's specific market-cap threshold for inclusion has been raised continually over time. Because a specific figure changes depending on the announcement date, it is more accurate to check the latest methodology document.
Preguntas frecuentes
Q. Does a stock's price rise when it is added to an index?
Funds tracking the index have to buy that stock, so short-term demand can arise, but there is no guarantee it will rise. Inclusion does not promise future returns for that stock, and this article is not a recommendation to buy any particular stock.
Q. Between price weighting and market-cap weighting, which is more accurate?
It is not a matter of 'accuracy' but of perspective. Market-cap weighting reflects the size of the whole market; price weighting reflects the price per share. However, price weighting is criticized for letting high-priced stocks have outsized influence, so most flagship indices today use market-cap weighting.
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