What Is the ASX 200 and How Does It Work?
Article Last Updated: 28 January 2021
The S&P/ASX 200 Index (ASX: XJO), or ASX 200, is an Australian share market index made up of the 200 largest companies listed on the local stock exchange.
These companies are of great interest to investors because the value of larger companies is often perceived to be less volatile. Some of the companies on the ASX 200 are also blue chips. This means that they’re household names in their sector, boasting financial strength and an excellent track record.
The ASX 200 is also a key performance benchmark for the Australian share market. If you’re new to investing, this article will give you a deeper understanding of what this index is, why it’s important, what it includes, and how you can invest in ASX 200 shares.
What is the Australian Share Market Index?
The Australian Securities Exchange, or ASX, is a marketplace where listed companies sell shares to investors to raise funds. For investors, it’s a place to both buy and sell their shares.
Although there are over 2,000 companies listed on the ASX, people often talk about what’s going on in the stock market by referencing the performance — that is, the combined share price movements — of an index rather than the entire stock exchange. The ASX 200 and the All Ordinaries Index (ASX: XAO), or All Ords, are both Australian share market indexes popularly used by analysts and investors.
The ASX 200 tracks the share price movements of the 200 largest listed companies by market capitalisation, expressed as points or a percentage. The All Ords represents the performance of the top 500 companies.
Market capitalisation is the estimated value of a company based on the number of shares on issue multiplied by the current trading price. To ensure the index continues to reflect the performance of the 200 largest listed companies, Standard & Poor (S&P) rebalances the ASX 200 on a quarterly basis in March, June, September, and December.
The importance of the ASX 200
The ASX 200 doesn’t tell the full story of the entire stock market, but it offers a solid approximation because the index accounts for around 80% of the value of the Australian share market.
The ASX 200 is a useful yardstick to compare the performance of an individual stock or even an entire portfolio. Since it contains a broad basket of stocks that are liquid, regularly traded and representative of major Australian listed companies, investing in the index can also help to achieve a diversified portfolio.
What does the ASX 200 include?
To be included in the ASX 200, a company must be listed on the stock exchange as ordinary or preferred stocks. Unlike ordinary shares, preferred shares don’t carry voting rights. Hybrid stocks that have both equities and fixed income characteristics are not eligible for inclusion.
Only ASX companies that are both large and liquid enough can become part of the index. In this context, liquidity refers to how easily a company’s shares can be bought or sold on the stock exchange, and it’s measured by how regularly these shares are traded and their trading volume.
The ASX 200 index comprises 11 sectors:
- Consumer Discretionary
- Consumer Staples
- Information Technology
- Real Estate
- Telecommunications Services
The most dominant sector is the Financials sector, which includes the major banks and other big players in financial services. The Materials sector is the second largest. It comprises resource giants such as BHP Group Ltd (ASX: BHP) and Rio Tinto Ltd (ASX: RIO), amongst others. The Healthcare sector comes in third.
How to Buy and Sell Shares on the ASX 200
There are two main ways to make share investments in the ASX 200.
You can invest directly by buying and selling shares in companies that are part of the ASX 200.
You can also invest indirectly through Exchange Traded Funds or ETFs. There are several ETFs based on the ASX 200. ETFs are traded like ordinary shares and can be purchased through your broker. An ETF allows you to buy the entire basket of stocks featured in the ASX 200 rather than any individual company. It’s a relatively low-cost way to earn a comparable return as the index while building a diversified share portfolio.
However, it’s important to remember that an ETF still exposes you to market or sector risk. If a key sector declines, then the value of your ETF would likely fall as well.
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