A lot of water has flowed under the bridge since the concept of stock indexing came into vogue. The entire world keeps tabs on the index numbers to understand various economies. Simultaneously, there is explosive growth in the amounts of funds invested in the Indexes that have proven to be highly popular investment vehicles.

Having said this, what makes me revisit this topic? And what I have understood that I wish to share with readers?

Let us begin at the very beginning. When, in 1896, Charles Dow launched the ubiquitous Dow Jones Index - both for Transportation and Industrial sectors - the idea was to let people know the current value of prominent stocks traded in the New York Stock Exchange. By knowing this number, investors were generally able to identify the trends of whether the market was going up or down and correlate the same with general business environment.

In a nutshell, the original purpose of publishing a stock index was to let the investors/traders know how the market is behaving. Since this index was, and still is, a price-weighted index, the movement of prices of the constituents had direct correlation with the index value.

Of late, market-capitalization-based indexes have flooded the market and all these are tracking either the entire market, or some sector, or a bunch of economies or maybe even the color of the constituent stocks' logos. The utility of a market-capitalization-based index stems from the fact that it represents the value of underlying stocks instead of only prices. Also, when the constituents of an index increase to gigantic proportions, such as the Russell 3000 or Wilshire 5000, then its claims of representing the entire market get a very sound footing.

Now as a market participant, why am I interested in the indexes? I can have two purposes today, unlike yesterday when I used to only track the market. Today I am interested in investing in the indexes too. I have plethora of options investing in Index Funds, Index Derivatives, Index ETFs and Index what-nots.

The dilemma starts here, really. When I want to invest in an Index Fund, what should I look for? Should I look for an index which gives me better returns or an index which represents the market and is accepted by wise men as a benchmark?

I think the idea should be to have separate indexes for market tracking and for investment. Why should one index, which is treated as the best barometer of the market, find itself eligible as an investment vehicle? Both the activities are like chalk and cheese. I shall invest in an Index based on my investment theories of having highest returns with lowest possible risks. I may not be interested in what the market tracking index is doing. In fact, my idea will be to beat the market tracking index constantly, which is definitely possible due to less than fully efficient markets. Not going into detail dissecting the theory of efficient markets itself, suffice it to say that each market has its fair share of insider information, resources, speculators and wildly different perceptions of future income streams to ensure that the stock price (or market value – based on this price) always remains adrift of the factual enterprise value.