- The S&P 500 is a broad stock market index, comprised of the 500 largest public companies in the United States.
- The diversity and size of the companies it accompanies make S&P a proxy for the entire stock market.
- You cannot invest in the S&P 500 itself, but you can buy an index fund that doubles your stocks and performance.
- Visit the Insider investment reference library for more stories.
People often say “The stock market is up” or “The market is down”. But the stock market is an amorphous thing, encompassing thousands of shares and dozens of stock exchanges. What they really mean is that a particular stock market index, or group of publicly traded companies, is up or down.
And if they’re in the U.S., chances are the index is either Standard & Poor’s 500 or S&P 500.
Named by the number of companies on its list, the S&P 500 is “a broad-based index that includes the cross-section of economic sectors such as information technology, health and discretionary consumption, as well as large companies in the financial, energy, industrial and consumer sectors, “says Solomon Tadesse, who directs quantitative research on US stocks at Société Générale.
“As such, the S&P 500 is a good indicator of the US stock market and, by implication, the economy and its short-term trends.”
Understanding the S&P 500 can be important for investors. Here is everything you need to know about this influential index.
What is S&P 500?
Developed by Standard & Poor’s (now S&P Global), the S&P 500 was launched in 1957. But its status as a proxy for the US stock market was cemented in 1968, when the S&P 500 became one of the indicators used by The Conference Board, the business association and research organization, to forecast economic trends.
This is what is known as a weighted index, which means that companies with the highest market capitalization (the total value of all their shares) have more influence in the calculations, so that the general index correlates more closely with the more broad.
The relative level of the index – or the collective value of the shares within it – is expressed in points. In January 2021, it was 3,750. So if the S&P 500 were to rise, say 10% during 2021, that would mean an overall gain of the index of 375 points.
What is the S&P 500 made of?
One of the reasons the S&P 500 is so widely cited is its composition: the 500 largest public companies in the United States (although it actually contains 505 shares because some companies issue more than one class of shares). They are organized into 11 industrial sectors.
Individual companies can run in and out. The US Index Committee of S&P Global reviews and rebalances the list at least quarterly, although it may happen at any time in an attempt to ensure that “the index continues to provide a representative reflection of the US large-cap stocks market,” according to a global S&P Blog.
For a company to qualify for the index, it must meet these criteria:
- Be based in the USA (although it may have operations abroad)
- Have a market capitalization of at least $ 9.8 billion
- Have high liquidity, with at least 10% of its shares outstanding in the public market
- It had positive results in the most recent quarter, and in the previous four quarters.
Which companies are on the S&P 500?
The S&P 500 is full of well-known names, many of them top-tier companies with strong track records of financial performance. As of December 2020, the 10 largest companies (by market capitalization) in the S&P 500 include:
- Apple Inc. (AAPL)
- Microsoft (MSFT)
- Amazon Inc. (AMZN)
- Alphabet Inc. Class A Shares (GOOGL)
- Class Inc. shares of Alphabet Inc. (GOOG)
- Facebook Inc. (FB)
- Tesla (TSLA)
- Berkshire Hathaway (BRK.B)
- Visa (V)
- Johnson & Johnson (JNJ)
What is the average return on the S&P 500?
Over the past 10 years, the S&P 500 has posted annualized returns of 11.18%. In 2020, it presented a return of 15.15%.
Since companies within the index are very diverse and collectively are worth about 80% of the total value of all United States stocks, these performance figures are widely seen as synonymous with the performance of the United States stock market in general.
Limitations of the S&P 500
Although seen as largely representative, the S&P 500 is not perfect.
The S&P 500 is a weighted index, which means that companies with a higher market capitalization have more influence in the calculations. As a result, the index can give “disproportionate weight to the largest companies,” warns Leyla Z. Morgillo, a certified financial planner at Madison Financial Planning Group. “These weights can distort the performance of the index, resulting in a handful of stocks driving the overall performance of the index. You wouldn’t be able to say that just by looking at the overall performance of the S&P 500, which is why it can be misleading to times. “
Case in point: only two high-tech companies, Apple and Microsoft, together account for more than 11% of the benchmark. “This can create some anomalies as other relatively smaller relative companies can get lost in the bundle,” says Dan Veru, chief investment officer at Palisade Capital Management.
In addition, in an increasingly globalized economy and stock market, the S&P 500 includes only companies based in the United States. This means that major foreign stocks (and sometimes influence the market), such as Alibaba Group in China or BioNTech SE in Germany, cannot figure in their performance – which makes it less useful as an indicator of economic trends.
Other significant stock indices
Despite the prominence of the S&P ‘500, investors also look at other indices. Among competitors:
- Dow Jones Industrial Average: one of the oldest indexes, the Dow tracks 30 leading American companies. Of course, this is much less than the S&P 500 – very few, some financial professionals believe. In addition, its weighting system, which is based on the stock price instead of the total market value, may unfairly penalize a company that has a stock split.
- Russell Indices: The Russell 3000 considers 3,000 companies based in the United States, significantly more than the S&P 500. The same is true of two other indices built from the Russell 3000: the high-capitalized Russell 1000 and the low-capitalized Russell 2000. Many investment funds managers prefer the Russell 3000 and its smaller brothers, although the latter may be more volatile than the S&P 500.
- The Wilshire 5000: This index covers about 3,800 shares (despite its name), which gives it the right to boast as the broadest stock market index – virtually all publicly traded companies based in the United States. Although obviously larger than the S&P 500 and therefore arguably more representative, Wiltshire also ignores foreign markets.
- The Nasdaq-100: This growth-oriented index includes 100 of the largest national and international non-financial companies listed on the Nasdaq stock exchange. The index is attractive due to the emphasis on the technology sector, probably the most influential fast-growing sector in the United States economy today. But its bandwidth is even narrower than that of the S&P 500 and following it could put investors at risk in the event of an industry slowdown.
How to invest in the S&P 500
You cannot invest directly in the S&P 500 – it is just a list, not an action in itself. But a variety of publicly traded mutual funds and ETFs (publicly traded funds) buy bonds that track the S&P 500, or a specific group of companies within it, such as companies that pay high dividends or companies that are more growth-oriented.
All major brokerages and financial services companies offer S&P 500 index funds: companies like Charles Schwab, Fidelity and Vanguard. The same is true with most online trading platforms and applications, such as Robinhood and Stash.
S&P 500 index funds are also popular with robot consultants like Wealthfront and Betterment, who use computer algorithms to invest and monitor investor portfolios.
The financial lesson
For more than half a century, the S&P 500 has been a thermometer for stock market performance in general. Because it represents the largest publicly traded companies in the United States, its performance is seen as a portrait of the state of business in the United States and, by extension, the economy of the United States.
But this index has some shortcomings. Their market capitalization weights may favor some companies, or sectors, over others; bandwidth does not always reflect the entire domestic stock market; and excludes companies that are not located in the U.S.
Still, the returns on individual stocks, equity funds and other assets are compared to the S&P 500. So it can also be a good tool for investors – to guide their individual investment choices, get a sense of how they are performing choices and even to duplicate through S&P 500 index funds.