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Hey Scoopers,
Happy Thursday!!
Today, we look at one of the world's most popular indices, the S&P 500, regarded by most as a barometer when it comes to investing in the U.S. stock market.
In this newsletter we dive deeper to see how the index fund has performed over the years and whether investing in it right now makes sense.
So, we see how the S&P 500 index works, how you can invest in it, and why doing so could be a smart move.
Let’s go 🚀
What is the S&P 500 Index?
The S&P 500 is a stock index comprising the 500 largest companies in the U.S. It is a statistical measure of the performance of the 500 largest stocks in the country, which is also the world’s largest economy.
The S&P 500 index is weighted by market capitalization, which suggests that a company’s valuation determines its influence over the index’s performance.
It also means each listed company doesn’t just imply it accounts for 1/500th of the index. For instance, the top seven companies in the S&P 500 account for 25% of the index.
Though they are the 500 largest publicly traded stocks in the U.S., Apple leads the pack with a market cap of roughly $3 trillion, while the smallest companies may have market caps of less than $15 billion.
Based on this performance-weighted market data for underlying companies, the value of the S&P 500 index constantly fluctuates throughout the trading day, similar to a particular stock.
Company weights and calculation
The weighting formula for the S&P 500 stocks is quite simple. You first determine the market caps of all the companies in the index and add them together.
The market cap of each company is then divided by the total to determine its weight in the index.
So, if the combined market cap of all S&P 500 companies is $50 trillion and a company is valued at $1 trillion, it will account for 2% of the index by weight.
Which Companies Are Part of the S&P 500 Index?
The S&P 500 index consists of 505 stocks issued by 500 different companies. There is a slight difference as companies such as Alphabet issue more than one class of stock.
Keeping this in mind, here are the ten largest companies in the S&P 500 index. This list and its sequence can and will change over time.
Source: Finasko
Why Use the S&P 500?
Most investors might wonder why the S&P 500 is considered so useful and used as a proxy for the country’s economy. Well, the index is a broad basket of stocks and avoids small or obscure companies.
Moreover, the 500 companies account for approximately 80% of the stock market value in the U.S.
S&P 500 vs. the Dow Jones Industrial Average
The Dow Jones Industrial Average is a price-weighted index. So, the companies with the highest stock price have the largest influence on the index, regardless of their underlying valuation.
The Dow Jones lists 30 companies and excludes some of the largest stocks in the market, including Berkshire Hathaway.
Further, as Dow Jones is price-weighted, a smaller company such as Goldman Sachs will have twice as much influence as Walmart over the index’s performance due to its high price.
But in terms of market cap, Goldman Sachs is worth just $118 billion, while Walmart is valued at $415 billion.
Due to its market-weight property, the S&P 500 is considered to be a much better indicator of the stock market by most investors.
S&P 500 vs. the Nasdaq Composite Index
The main difference between the S&P 500 and the Nasdaq Composite index is that stocks part of the latter must be traded on the Nasdaq stock exchange.
Comparatively, the S&P 500 index has a mix of stocks that are part of the NYSE and Nasdaq exchanges.
Moreover, the Nasdaq has a much higher proportion of technology stocks, making it a tech-heavy index. So when the tech sector underperforms, the Nasdaq Composite also tends to trail the S&P 500.
Another significant difference is that while the S&P 500 consists of large-cap stocks, the Nasdaq Composite contains all qualified stocks listed on the exchange, making it more diverse and inclusive.
S&P 500 vs. the Russell Indexes
The Russell Indexes are designed to provide benchmarks for the entire stock market.
For example, the Russell 1000 is the closest comparison to the S&P 500 as it is a large-cap index consisting of 1,000 stocks, accounting for 93% of the stock market.
Source: FTSE/Russell
Additionally, the Russell 2000 index is considered the benchmark of small-cap performance in the U.S.
Collectively, the Russell 1000 and Russell 2000 (known as the Russell 3000) is a broad stock market benchmark index.
How Can You Invest in the S&P 500 Index?
You can invest in the S&P 500 by purchasing shares of a mutual fund or exchange-traded fund (ETF) that passively tracks the index.
These investment vehicles own stocks that are part of the S&P 500 in proportional weights, allowing them to deliver similar returns after accounting for fees and commissions.
Investors can consider buying low-cost ETFs such as the Vanguard S&P 500 ETF (VOO), which trades like a stock. With meager fees, the VOO ETF has delivered identical performances to the S&P 500 index over time.
Why Should You Invest in the S&P 500 Index?
According to legendary stock market investor Warren Buffett, a low-cost investment fund such as the S&P 500 can help you generate inflation-beating returns over time.
In fact, over the last three decades, the S&P 500 index has returned 10% annually after accounting for dividend reinvestments. It means a $10,000 investment in the index in late 1993 would be worth over $175,000 today.
During this period, investors have wrestled with multiple economic downturns, such as the dot-com bubble, the financial crash of 2008, the COVID-19 pandemic, and the recent period of interest rate hikes.
Typically, passively investing in indices such as the S&P 500 helps you:
👉 Gain exposure to an inflation-beating asset class at a low cost
👉 Provide your equity portfolio with diversification
👉 Lower investing risk considerably
Moreover, investing in the S&P 500 index will help you beat over 90% of active fund managers, making this simple strategy a winning bet for those who don’t have the knowledge or expertise to pick individual stocks.
In a nutshell, investing in the S&P 500 is a way to get broad exposure to profitable businesses in the U.S. at a very low cost. Over time, the S&P 500 should deliver robust returns for your portfolio with minimal effort.
DISCLAIMER: None of this is financial advice. This newsletter is strictly educational and is not investment advice or a solicitation to buy or sell assets or make financial decisions. Please be careful and do your own research.