Indexing has become an invaluable investment cornerstone, shaping how portfolios are constructed and how markets are understood. And while many of us are familiar with the S&P 500, the NASDAQ 100 or the Dow Jones Industrial Average, do we really understand their differences, how they work, and how it can impact us as investors?
Beneath the apparent simplicity lies a world of nuanced differences, changing markets, and evolving methodologies that can have an impact on investment outcomes. What surprises might you find as you look under the hood?
Indexing construction: How do the indexes decide what and how much?
Indexes aren’t interchangeable. Their construction rules, goals, and inclusions vary widely.
- Market cap weighting: Many of the most “investable” indexes like the S&P 500 are market cap weighted. This means that the largest companies make up the largest percentage of the index. The index morphs over time as some companies grow and others retreat. Companies like Apple, Nvidia, and Microsoft all make up over five percent of the S&P 500 versus the smallest companies that might be a mere 0.01%.
- Equal-weight: This shifts indexing upside down by giving an equal weight to every company. That means that a small company like Campbell Soup would have the same weighting as Microsoft. This tends to mute the impact of the Mag 7 type companies, but can dramatically overrepresent the smallest companies making that index look more like a mid-cap fund.
- “Passive” Doesn’t Mean Unchanging: We often term investing in indexes as passive investments since the funds don’t make active investment decisions, but the indexes themselves do. Their rosters shift regularly through rebalancing and updates, which can quietly affect what’s actually inside your fund. The S&P 500 rebalances quarterly. Interesting tidbit: when Enron collapsed and was removed from the S&P 500, Nvidia replaced it.
There is no inherent right or wrong index construction or rebalancing methodology. At the end of the day, most investors are looking for transparency in the process and a fit in their portfolio.
Value vs. Growth: Can a Stock Be Both?
We used to know basics like dividend paying stocks were value and that tech stocks were growth. Is that still the case today and how are the indexes handling this shift?
What happens when a company doesn’t fit neatly into an investment “style”? Some stocks straddle the line, showing traits of both value and growth, depending on which financial yardstick or index you use.
S&P and Russell, two of the large index providers, look at this differently. Not surprisingly, the Mag 7 stocks (Alphabet, Tesla, Apple, Amazon, Meta, Nvidia and Microsoft) are all represented in the growth indexes for both the Russell 1000 and the S&P 500. Many might not realize that Amazon is represented in the value indexes for both the Russell and S&P, while Apple and Alphabet are in the Russell 1000 Value and Tesla and Apple are part of the S&P 500 Value.
If you are using style-specific indexes to reduce in today’s tech- and AI-dominated investment landscape, the ability to find defensive options in things like value may be challenged—especially if you are just looking at the label and assuming value is not tech and AI.
Is Korea an Emerging Market? Depends Upon Who You Ask.
Are Poland and South Korea developed or emerging markets? MSCI has South Korea in its Emerging Markets indexes, FTSE considers it developed. What is the potential impact? If you invest in VWO Vanguard’s emerging market index ETF which follows the FTSE, then you will have no exposure to South Korea. However, if you invest in iShares EEM or IEMG, which follows MSCI index, then South Korea will be included in your portfolio.
As an investor, should you care? For many investors with limited weighting to emerging markets or non-US investments, you would have a hard time noticing differences in the performance of your overall portfolio. Given that South Korea accounts for 15% of MSCI emerging markets indexes, a substantial shift in South Korean stocks relative to other emerging markets would be required to make a noticeable impact. (Source: BlackRock; as of 2/6/2026 South Korea made up 15.01% of IEMG.)
Consistently applying the same index methodology to both developed and emerging markets often results with South Korea and Poland in one or the other category.
Emerging Markets: Constantly Changing
The bigger impact on investors is not necessarily who is included, but how much of the index. In recent years, the inclusion of China A shares in 2018 caused the representation in the MSCI Emerging Markets index to peak at over 40% by 2020. This weighting, along with geo-political risks and reticence of U.S. investors to invest in China, led to the creation of additional emerging markets index funds that exclude China.
The emerging markets have at times been dominated by natural resource intensive economies like Brazil and Russia. In fact, Petrobras, the large Brazilian energy company was the largest component in the index. Around 2008 when energy prices were surging on the back of insatiable demand in the emerging economies, investors would use emerging markets as a proxy for the energy and commodities trade which had large producers (Brazil and Russia) and large marginal consumers (China and India). It has been a long time since we used the BRIC (Brazil, Russia, India and China) acronym.
Today, energy makes up less than 4% of the MSCI Emerging Markets Index with Information Technology at 28%. Over 40% of that is Taiwan Semiconductor at nearly 12% of the total index. So, even the emerging markets are participating in the AI trade.
Aggregate Bond Indexes: Does Market Cap Make Sense for Bonds?
Most bond indexes are weighted by the total debt a company or government has issued. Meaning, the most indebted entities have the greatest impact on your returns. But is that really what you should aim for? Bonds are straightforward investments, with interest rates determined by maturity (when the bond principal is repaid) and credit quality (the likelihood of the issuer to paying interest and principal). As a result, diversifying across a large number of U.S. treasuries may offer limited value, as they all have the same issuer: the U.S. government.
When you invest an ETF or mutual fund tied to the Bloomberg U.S. Aggregate Bond Index or the “Agg,” you are investing proportionately based on bond issuance. So, if the U.S. government continues to grow its deficit and issues more debt, the index will reflect that, leading you to own proportionately more U.S. treasuries. If the government opts for longer-term debt, you will be exposed to greater interest rate risk.
While cost and ease of implementation is valuable, many investors may want to be more prescriptive in selecting the overall credit quality and interest rate sensitivity of their bond portfolio and become less reliant on the composition of the index.
An investor with mostly stocks may want high quality and longer duration bonds like long-term treasuries to provide protection against recessions and events that would be harmful to the heavy stock portion of their portfolio. The flipside would be someone that is very bond heavy. They may benefit from lower quality and shorter-term bonds that provide greater income and have less interest rate sensitivity.
There is a place for indexing in bonds, but it may make sense to complement this with a more prescriptive and intentional allocation.
The composition of major indexes has changed dramatically over time, reflecting shifts in global economies and investment trends. Emerging markets, once dominated by natural resource giants, are now led by technology companies. Meanwhile, traditional bond indexes reward the largest issuers, which often means greater exposure to entities with substantial debt, such as the U.S. government.
While index investing remains a convenient and cost-effective strategy, a tailored approach that considers credit quality, duration, and personal portfolio goals can help investors better manage risk and seek optimal outcomes. By complementing index investing with intentional allocation, investors can help ensure their portfolios remain responsive to changing markets and individual needs.
