What Is the Russell 2000 Index?
The Russell 2000 is a stock index that tracks the performance of approximately 2,000 of the smallest publicly traded companies in the United States. Introduced by the Frank Russell Company on January 1, 1984, the index is now managed by FTSE Russell, a subsidiary of the London Stock Exchange Group.
What Companies Make Up the Russell 2000?
The Russell 2000 is designed to be a comprehensive and unbiased gauge of the performance of the small-cap sector in the United States. The small-cap sector refers to companies with a small market capitalization, or the company’s share price multiplied by the number of shares outstanding.
To remain comprehensive and unbiased, the Russell 2000 is reconstituted each year, which means that the index is reevaluated to determine if any companies need to be added, removed or rebalanced. Essentially, this annual adjustment ensures that only small-cap companies are included in the index. If companies get too large, they are removed from the index and replaced with smaller firms.
The largest company in the Russell 2000 has a market capitalization value of nearly $15 billion. The smaller companies that make up the Russell 2000 have values of about $200 million. As of March 31, 2022, the median company value was almost $1.1 billion.
The Russell 2000 is a subset of the Russell 3000, which aims to approximate the entire United States stock market. The companies, or constituents, that make up the Russell 2000 equate to roughly 10% of the value of the Russell 3000. The remaining 90% of the Russell 3000 is attributable to larger companies that belong to another subset, the Russell 1000.
How Does the Russell 2000 Work?
Not all companies within the Russell 2000 are given the same weight. The Russell 2000 Index uses a capitalization-focused methodology to weight the stocks it tracks. As a result, the companies with the largest market capitalizations (share price multiplied by the number of shares outstanding) have the greatest influence over the performance of the index.
Let’s Talk About Your Financial Goals.
How Is the Russell 2000 Used?
As outlined below, there are three main ways that the Russell 2000 Index can be used by those interested in investing.
- Market Monitoring
- The most common use of the Russell 2000 is to monitor market performance and gauge economic sentiment, particularly in the small-cap space.
- Performance Benchmarking
- Beyond just monitoring the market in a broad sense, many investors use the Russell 2000 to gauge the performance of specific investments. For example, an investor in an actively managed small-cap fund can refer to the Russell 2000 to evaluate whether the fund managers are performing well in comparison to the broader market.
- Index-linked Investing
- The third application of the Russell 2000, which is arguably the most beneficial for your retirement and personal finance situation, is index-linked investing. Also known as passive investing, this is a widely popular and low-cost way to replicate the returns of the Russell 2000 (or any other index), rather than trying to outperform it.
How Index-linked Investing Works
Index-linked investing involves setting up an investment fund with positions that mirror the companies in an index like the Russell 2000. Then, depending on how the various companies perform, the fund is adjusted accordingly. This means buying more stock of companies that are performing well and selling the stock of companies that are underperforming.
The result is an investment return that matches the performance of the index, minus a very modest management fee. This is the essence of index investing — you get diversified exposure without exorbitant costs or administrative fees.
Index-linked investing is most often associated with the direct ownership of index mutual funds and exchange-traded funds. However, index-linked investing is also a prominent feature of indexed annuities, which are financial contracts issued by insurance companies to individuals looking to save for retirement. The typical indexed annuity works as follows:
In exchange for an upfront payment, the insurance company provides the individual, or annuitant, a guaranteed stream of future income, with the opportunity to increase future payouts based on the performance of an index like the Russell 2000. In this hypothetical case, when the Russell 2000 performs well, the future income stream grows (up to stated limits), but the value of the annuity never goes down.
Other Popular Stock Market Indexes
While the Russell 2000 is widely monitored by investors, the stock index is only one of many. A number of more well-known indexes exist, including those outlined below.
- Russell 1000 Index
- The Russell 1000 Index tracks the performance of the 1,000 largest companies in the United States. Like the Russell 2000, it uses a capitalization-weighted methodology to determine how much weight each constituent is given. The combination of the Russell 1000 and the Russell 2000 creates the Russell 3000, which seeks to approximate the entire United States stock market.
- S&P 500
- The S&P 500 Index, also a capitalization-weighted index, tracks the performance of 500 of the largest companies in the United States. It’s arguably the most referenced stock index in the world and offers a quick and telling view of the United States market.
- Nasdaq Composite Index
- The Nasdaq Composite Index tracks the performance of over 2,500 technology-related companies listed on the Nasdaq Stock Market. Like the S&P 500 and Russell 1000, it utilizes a capitalization-weighted methodology. However, unlike these indexes, the Nasdaq contains foreign companies.
- Dow Jones Industrial Average
- The Dow Jones Industrial Average tracks the performance of 30 of the largest publicly traded companies in the United States. Its constituents represent all industries except transportation and utilities. Unlike the indexes above, it maintains a price-focused methodology to determine proportion sizes. As a result, companies with the highest share prices have the greatest influence over the performance of the index.
Russell 2000 Index Historical Data
As of May 4, 2022, the closing value of the Russell 2000 was 1,949.92, which is 20.7% off the all-time high of 2,458.86 that was reached in early November 2021. The pullback has been frustrating for investors, but it’s explainable.
While we are largely past the worst of the COVID-19 pandemic, supply chain disruptions and inflationary pressures persist. These factors, along with rising interest rates and increasing geopolitical uncertainty, have seriously blunted small stock valuations in recent months.
Despite these headwinds, small-cap stocks have been quite prosperous over the long-term. According to data compiled by FTSE Russell, the annualized return of the Russell 2000 has been 11% over the last ten years. This trails the 14.5% return reported by large-cap stocks. Nevertheless, having a mix of investments across all company sizes and geographic areas is important, regardless of the near-term performance of any specific markets.
