[Guide] Which Japanese Stock Index Should You Buy: Nikkei or TOPIX?

The legendary value investor Warren Buffet himself have said that we should all own index funds, but which one is best for Japan?

I know many of you do not have direct access to Japanese stocks, but as you are reading this, you clearly want to invest in the Japanese economy.

I have some great news for you: Almost all stock-brokers provide index funds in Japan’s biggest indexes,,the Nikkei 225 and the TOPIX.

These are indexes of the most valuable companies in Japan, and are basically the Japanese versions of the American S&P 500 and Dow Jones Indexes.

Funds following these indexes are so-called “passive funds”, as all they do is automatically buy and sell stocks based on if they are added or removed from the indexes. Hence, there are no overpaid fund managers who charge fees for their services and owning them tend to cost close to zero in fund fees.

So, what is the difference between the Nikkei 225 and the TOPIX, and which one should you invest in?

The Nikkei 225

The Nikkei 225 is an average of the 225 largest companies in Japan. The index is named after the Nihon Keizai Shimbun (commonly known as Nikkei), or the Japan Economic Newspaper, which sponsors the calculation of the index. The Nikkei 225 was created in 1949 and is the oldest stock index in Asia.

The Nikkei 225 weights the stocks it contains after their price on the stock market. That means that even though, for example, the trading company Itochu has a much higher enterprise value than the gaming company Nintendo; because Nintendo’s stock trades at JPY 56,340 compared to JPY 3,533 for Itochu, Nintendo weighs much higher than Itochu in the Nikkei 225 Index.

This weird compilation of the Nikkei 225 makes it a relatively bad sample of the overall Japanese economy. Another consequence of this weighing method is that stocks in the Japanese tech sector usually weighs higher than other sectors. This is because the price of tech stocks have risen faster than other sectors in recent years, and hence have a bigger weight in the index.

The TOPIX

The TOPIX is a much more accurate index of the Japanese overall economy than the Nikkei 225. This is because it reflects a fairer depiction of price changes and includes the largest companies trading on the TSE.

In fact, the TOPIX was created in 1985 as a way to follow the performance of the Japanese economy more accurately than the Nikkei 225. They achieved this by not having a limit of how many companies can be included, and requiring stocks from every major sector in the Japanese economy (so far, over 1700 companies in 33 business sectors are included).

There is no limit to how many companies are in the TOPIX, but most funds tracking it usually limits themselves to the 1,000 (referred to as TOPIX 1000), 500 (TOPIX 500), or 100 (TOPIX 100) largest Japanese companies.

Conclusion: Which Index Should You Invest in?

Both the Nikkei 225 and the TOPIX are good ways to get exposure to the Japanese stock market. However, if you want a more accurate depiction of the Japanese economy, I recommend that you buy a fund following TOPIX, as it weights the stocks it follows based on their enterprise value and include every major sector in the Japanese economy.

On the other hand, if you are more bullish on the Japanese tech sector, a fund following the Nikkei 225 might be a better bet, as tech stocks are generally weighted higher in that index.