What is the Russell 2000 Index?

You probably hear it mentioned all the time in the business news, but what exactly is the Russell 2000 Index? In essence, it's the small stocks index.

The Russell 2000 Index measures the 2000 smallest companies in the Russell 3000 index, representing about 10 percent of the total market capitalization of the 3000 index. While the Russell 2000 looks at small stocks, it doesn't cover the smallest ones. The very smallest mini- and micro-cap stocks are left out of the Russell 3000 (a broad-based index of 3000 companies, covering about 98 percent of the U.S. equity market). So those smallest stocks are left out of the Russell 2000, too.

So these stocks are small, but not tiny. The average Russell 2000 company has a market capitalization of about $530 million, and a median market cap of about $410 million. The largest Russell 2000 company has a market cap of about $1.4 billion, which is pretty small when compared to a company like General Electric (market cap of more than $400 billion).

The index is also pretty diversified, and is the most quoted index featuring smaller companies. However, the focus on small companies also means the index tends to be volatile, as small-cap companies don't tend to lead the trend in their industry.

The index is reconstituted every year, according to Russell. This ensures that companies that have grown into large ones don't distort the small-cap index. It is weighted based on market capitalization, which is the same method used by the S&P 500 and the Wilshire 5000.

The Russell 2000 is constituted in a similar way as the Standard & Poor's 500 Index; however, the S&P 500 looks at "large cap" stocks.

It is the most common benchmark for small-cap mutual funds, but there are other small-cap indexes as well. For instance, there is the S&P 600, from Standard & Poor's, which is not as commonly used.

The Russell 2000 is published along with other indexes by the Frank Russell Company. This company publishes 21 U.S. equity indexes overall, although the Russell 2000 is the best known of them.

For those looking to invest in small-cap stocks, the Russell 2000 is a useful resource to take the pulse of the small-cap side of the market. However, the leading companies in the major industries are not represented in this index, and investors would be wise to keep that in mind and be cautious and prudent in their investment strategies.