If you found this article by doing a web search for “market portfolio”, unless you have taken Economics 101 in college, you may be surprised to find out that a market portfolio only exists in the imagination of those smart guys who write textbooks and develop economic models. If somebody tried to create a true market portfolio, it would have to contain not only all the traditional investment vehicles, but also things like cars, televisions, jewelry, art and anything imaginable of any value, in exactly the same proportion as those things exist in the world. Needless to say, this task is impossible.

The Market Portfolio as a theoretical concept is very important in understanding basic economic principles as well as for developing and understanding economic theories and models. But this article was written for the regular folks, rather than for professors of economics, and we are going to look at what is often (although somewhat mistakenly) described by the term market portfolio. Market indices or averages are often used as a representation of the stock market, and this is what we are going to discuss.

The S&P/TSX Composite Index (the TSX) is the main stock index in Canada representing approximately 71% in terms of market capitalization of all stocks trading on the Toronto Stock Exchange. There are certain requirements for the stocks to be included in the TSX, including size (market capitalization), liquidity and being listed on the Toronto Stock Exchange. Therefore, the index falls short of representing even the Canadian stock market, because many companies are either not listed or fail to meet the requirements. But there is nothing in existence that would represent our market better.

An average, as opposed to an index, represents a selection of stocks based on their prices, rather than market capitalization of the companies. Indices and averages behave slightly differently based on what types of stocks are moving: higher priced ones or those with the largest market caps.

An index fund (sometimes referred to as a market portfolio) is a fund invested in the stocks represented in the underlying index or average in exactly the same proportion as they are represented. If you had invested $100 in the S&P/TSX index fund in 1950, by 2008 your hundred bucks would have grown to approximately $50,000 by 2008, which represents an average annual return of 10.1%.

Many individual investors prefer index funds, because they like to believe that they know where the market in general is going. This gives them a certain element of certainty. Although an index fund itself may be relatively new, the underlying index or average has been around for a long time and its performance is quite impressive.

Nikolay Sisan is a Certified Financial Planner and freelance writer in Vancouver.