The S&P 500, also referred to as the Standard & Poor’s 500, is a stock market index that is considered a measure to track the performance of overall stock market. 500 large U.S. companies are included in the S&P 500 index. The publicly traded companies included on the S&P 500 cover 11 sectors and present a snapshot of the health of the U.S. stock market and the larger economy.
Simply put, the S&P 500 is the performance gauge of America’s 500 largest stocks, making it a widely used investment benchmark.
This article explains what is the S&P 500 index, what it is for, and how you can invest in the S&P 500 index for your investment goals.
What is the S&P 500 Index?
The S&P 500 is an index (or Standard & Poor’s 500 index) that tracks the performance is a market capitalization weighted index of 500 leading U.S. companies. Although it’s called the S&P 500, there are 503 larger companies in the index due to some companies having multiple share classes.
It’s not the accurate list of the leading 500 U.S. companies by market cap because it follows the specific selection criteria.
The S&P 500 Index is nevertheless viewed as one of the best gauges of major American equities’ performance and the overall stock market. However, the standards may change over time.
The S&P 500 signifies around 80% of the current U.S. market capitalization. As of May 2024, 503 components formulate the S&P 500, with an approximate $43.4 trillion total market capitalization.
S&P 500 stocks represent the U.S. economy’s performance accelerators. As of Apr. 30, 2024, the 10 dominant constituents of the S&P 500 by index weight consist of:
- Microsoft Corp. (MSFT)
- Apple Inc. (AAPL)
- Nvidia Corp. (NVDA)
- Amazon.com Inc. (AMZN)
- Alphabet Inc. A (GOOGL)
- Meta Platforms Inc. Class A (META)
- Alphabet Inc. C (GOOG)
- Berkshire Hathaway B (BRK.B)
- Eli Lilly & Co. (LLY)
- Broadcom Inc. (AVGO)
Three components account for the largest share of companies in the S&P 500 in April 2024: Information Technology 29.2%, Financials 13.1% and Healthcare 12.3%.
Why Use the S&P 500?
You might be curious to know why the S&P 500 is regarded as an ideal market and economic indicator. Because the S&P 500 carries a broad basket of stocks without numerous small or ambiguous companies.
It includes the companies most dominantly operated by individual investors. In fact, the 500 companies represent approximately 80% of the overall value of the stock prices in the U.S.
Company Weighting Formula and Calculation
The weighting formula for S&P 500 stocks is quite simple. First, the company’s market-cap weighting is calculated by multiplying each company’s outstanding shares by its current share price.
Next, the market caps of all S&P 500 largest companies in the U.S. are accumulated. Each company’s market cap is divided by the total to find its weight in the index.
For example, if the aggregated market cap of all S&P 500 companies is $40 trillion and one company owns a $1 trillion market cap, it would account for 2.5% of the index by weight.
How to Invest in the S&P 500?
The simplest way to invest in S&P 500 ETFs is that the investors can gain exposure through discount brokers with commission-free trading. S&P 500 index funds access the market through brokers and discount brokers and may be approached directly from the fund companies.
Employers may also invest in ETFs and mutual funds via employee 401 (k) programs, robo-advisor platforms, or Individual Retirement Accounts (IRA).
The investment cost ratio for ETFs is the overall annual cost disbursed to the fund manager by investors. These may be categorized as front-end or back-end loads.
Investors can assess performance by reviewing each fund’s fact sheet on the company’s website. Using the name and ticker symbol of the funds, capitalists can figure out the total funds they have to invest.
What Companies are Included in the S&P 500?
To qualify for the index, companies must fulfil certain requirements. Along with other factors, companies must:
- Possess a market capitalization which represents the total value of the company’s outstanding shares – of at least $15.8 billion.
- Be located in the U.S.
- Be organized as a corporation and provide common stock.
- Be registered on an eligible U.S. exchange. (Real estate investment trusts, known as REITs, qualify for inclusion.)
- Have positive earnings over the most recent quarter, apart from four most recent quarters added together.
Owing to these standards, only the country’s most top-ranking and financially stable firms can be incorporated in the S&P 500. Also, that list is quarterly reviewed and updated to evaluate the companies’ market performance.
Limitations of The S&P 500 Index
A key limitation of the S&P 500, like other market cap weighted indexes is that it can become skewed when certain stocks in the index become overvalued. The stock generally inflates beyond rational metrics or price of the index if it has a large proportion of the index while being overvalued.
A company’s growing market cap doesn’t essentially indicate its fundamentals. It simply indicates the stock’s rise in price relative to the shares outstanding.
As a result, equal-weighted indexes have gained widespread popularity. Each company’s stock value shifts has a greater impact on these indexes.
Advantages of Investing in the S&P 500 Index
Let’s have an overview of the disadvantages of investing in the S&P 500.
Consistent Long-Term Returns
Although profits in any single year can fluctuate significantly over a long-term period, the S&P 500 has persistently performed.
Access to the World’s Largest Publicly Traded Companies
Investing in the S&P 500 index allows individuals to access the world’s most dynamic companies, such as Amazon, Apple, Johnson & Johnson, and Walmart.
Complex Assessment Not Required
Putting funds into S&P 500 through an ETF or index fund implies that investors don’t have to pick or analyze stocks.
Can Be a Fundamental Holding
S&P 500 index funds or exchange-traded fund (ETFs) are liquid and operate with narrow bid-ask spreads, making S&P 500 funds and ETFs perfect as core holdings for most investment portfolios.
Disadvantages
Here’s a summary of the disadvantages of investing in the S&P 500.
The Index is led by large-cap companies, with its 10 biggest components making up almost one-third of the index. It means that the S&P 500 index has constrained exposure to small-cap and mid-cap stocks that may be capable of growing much faster.
The Index Has Risks Inherent in Equity Investing
The S&P 500 or the stock market benchmark also has risks inherent in equity investing, such as volatility and downside risk. It can be challenging for new investors to endure such volatility.
Only Includes U.S. Companies
The S&P 500 only includes U.S. companies.
S&P 500 Vs Dow Jones: What’s the Difference?
The DJIA, or simply the Dow, is another stock market index that comprises a large, long-standing corporation.
Here’s a glimpse of what is the S&P 500 and its differences from Dow Jones:
- The Dow includes only 30 companies, each of which is identified as a leader in its respective industry. While the S&P 500 includes 500 leading companies as the term indicates.
- The Dow is weighted depending on the share price of each company, not the market cap. The companies’ selection based on the market cap indicates that the companies with higher share prices carry more weight. The index is determined by adding up the share prices of all 30 companies, adjusting for weight, and then dividing by a predetermined constant, called the Dow Divisor.
- The Dow consists of nine sectors, while the S&P 500 covers 11 sectors.
Both the Dow and the S&P 500 incorporate companies that are considered the country’s best organizations. If you’re keen on connecting with these companies, it’s crucial to understand the S&P 500 index and stock market trends.
Final Thoughts
The S&P 500 is one of the most extensively used indexes for the U.S. stock market. The index has historically been used to offer a perspective on the direction of the stock market. It was developed by a private company.
But the S&P 500 serves as a common benchmark to measure the performance of the market economy at large. Also, these 500 companies symbolize the most established and liquid companies in the U.S from manufacturers and banks to technology and software companies.
It was all about “What is the S&P 500 index?” Feel free to contact Quadrawealth today to explore more investment options and get started your finance journey today.
FAQs
Q1. Do S&P 500 ETFs and Funds Pay a Dividend?
A: S&P 500 index ETFs and mutual funds pay dividends to the included companies. The S&P 500 index holds a dividend yield of about 1.47% as of April, 2024.
Q2. How Much Funds One Has to Invest in the S&P 500?
A: The difference in fees between S&P 500 index funds and ETFs these days is minor. For example, some of the largest and most notable S&P 500 ETFs have a very low expense ratio.
Q3. What are the Requirements for a Company to be the Part of S&P 500?
A: For a company to be eligible for the S&P 500, it must be based in the U.S, it must have positive as-reported earnings over the most recent quarter as well as over the four most recent quarters combined. And it should have an unadjusted market cap of at least $12.7 billion (46.61 billion AED) and a float-adjusted market cap of at least 50% of that minimum threshold.
