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How do you custom design your “do-it-yourself” stock index?

What you need to know about index investing

An index in stock investing, a so-called stock index, is typically a portfolio of stocks that share common criteria. The most common stock indices are country and company size indices. An S&P 500 index holds primarily the shares of the largest 500 US companies which are quoted on the US stock exchange (the DAX30 index holds primarily the shares of the 30 largest quoted companies on the German stock exchange). Investors typically buy such indices by buying an index fund or by buying an Exchange Traded Fund (ETF). This is called a passive investment, as the shares are selected by standard rules that mostly stay the same. An active investment is based on investment strategies where additional analysis and evaluation are used for stock picking.

What you need to know about custom or do-it-yourself indices

A custom or do-it-yourself index is similar to a standard index: it is a stock portfolio where the stocks share common investment criteria. Unlike a standard index where a third party defines the criteria, custom indices are based on criteria individually selected by investors according to their own investment strategies. For that reason, custom indices can have design, cost and safety benefits that normal indices don’t have. The Obermatt stock screener and analysis is helpful for custom indices as it allows investors to freely select and combine investment criteria.Generally, it is a custom or do-it-yourself index if the investment criteria remain mostly the same and stocks are replaced in consistent time intervals based on changes in stock performance (how often to rebalance your portfolio).

How you create your owndo-it-yourself index

Create your own custom index in three steps:

Select the group of shares (one or several countries or sub-segments of countries like the largest 100 companies of a country or region)
Select the investment criteria (one or several criteria to screen for your stock recommendations)
Purchase the recommended shares or rebalance your existing custom index (more on rebalancing your portfolio)

One of the advantages of index investments is the diversification effect which typically reduces risks in your portfolio. As index investments hold several shares, the risk from each individual stock is usually reduced. The finance experts E. J. Elton and M. J. Gruber have shown in a large research project involving thousands of shares in 1977 that most diversification benefits are achieved with a portfolio of twenty to thirty shares. For this reason, it can be sufficient to hold 20 – 30 shares to benefit from the diversification effects of passive index investments. In case of a custom index, investors have additional design, cost and safety benefits over standard indices.