Lesson 6 of 12 · All lessons in this module
  1. Money-weighted return
  2. Time-weighted vs money-weighted returnVideo lesson
  3. Which return to report: managers, investors and GIPS
  4. Integrated cases: balance tables, money-weighted and time-weighted returns
  5. What an index is: value, price return and total returnVideo lesson
  6. Index objectives, custom indexes and choosing a version
  7. Building an index: target market, constituents and weighting
  8. Price-weighted and equal-weighted indexesVideo lesson
  9. Market-cap, float-adjusted and fundamental weightingVideo lesson
  10. Rebalancing, reconstitution and what indexes are used for
  11. Rebalancing in shares, weight drift and reconstitution rules
  12. Integrated cases: one market, three weightings and a stock split

This lesson is part of the 2027 curriculum. You are following the 2026 curriculum, where it is not taught in this form. Switch if you are sitting the exam under the 2027 curriculum.

Lesson 6 of 12 · 11 min

Index objectives, custom indexes and choosing a version

An index is a benchmark and a blueprint for passive funds, built in five steps from a stated objective; custom indexes bend the rules toward a target, and the right version (price or total return) and weighting depend on what the index is used for.

In short

  • Indexes are indicators, benchmarks and the blueprint that index funds and ETFs copy. Passive investing replicates an index at low cost; active investing tries to beat one.
  • Custom indexes screen and weight constituents toward a goal: factor (value, momentum), thematic, income-oriented, risk-weighted (e.g. minimum variance) and active-strategy indexes.
  • Five steps: objective → constituent selection → weighting → calculation (start date and value) → maintenance (rebalancing, reconstitution, corporate actions, rule reviews).
  • Use a price return index for non-dividend payers, short-term trends and strategies that do not reinvest income; use a total return index for dividend payers, long horizons, mutual funds and dividend reinvestment plans.
  • Market-cap weighting brings concentration risk in the largest firms; equal weighting spreads influence but can tilt toward sectors; fundamental weighting suits value-oriented investors and leaves out firms without the chosen metric.

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