The simplest way to invest in the S&P 500 is to buy shares of an S&P 500 exchange-traded fund or index fund, which are collections of stocks grouped together so that the fund’s performance mimics the S&P 500 index, an index of 500 stocks selected by the credit rating agency Standard & Poor’s.
Here’s what you need to know about how to invest in the S&P 500.
Passively Invest in the S&P 500
The S&P 500 provides people with little investing knowledge an easy way to make broad, diversified investments with a single purchase. The S&P 500 has averaged a return of about 10 percent a year over the course of its existence, and you can invest in the S&P 500 in two ways:
- Exchange-traded funds
- Index funds
To invest in the S&P 500, you can open an account with a brokerage firm such as Scottrade, E-TRADE, Fidelity, Charles Schwab or TD Ameritrade. Most brokerages have easy-to-use online platforms, and you can buy and sell most types of investments for a per-transaction fee. If you have a 401k or IRA, the same site where you view and manage your account will likely include options for brokerage services.
What Is an Exchange-Traded Fund?
An ETF is a basket of stocks that are bundled together to create a single fund that can then be broken up into shares and sold to individual investors. It gives investors an easy, affordable way to buy a piece of the S&P 500 or another index.
Although an investor could certainly just go out and purchase one share of stock in all 500 of the companies in the S&P 500, aside from being incredibly expensive, that portfolio wouldn’t be cap-weighted and wouldn’t match the S&P 500’s performance. With the SPDR S&P 500 ETF, each individual share costs less than $300, and the fund carefully balances stock purchases to ensure that it matches the S&P 500.
That does come at a small price, though. The company that manages the ETF charges an expense ratio, which is essentially a small management fee. For the SPDR S&P 500 ETF, it’s just 0.09 percent.
Although it’s the most popular, the SPDR S&P 500 ETF isn’t the only ETF that tracks the S&P 500. The iShares Core S&P 500 ETF and the Vanguard S&P 500 ETF also do so. Each is managed by a different company and offers slight differences in their expense ratios and their “tracking error,” or how closely the fund matches the performance of the S&P 500.
What Is an Index Fund?
Index funds are mutual funds that, just like an ETF, mimic the performance of a particular stock index. Although very similar in nature to ETFs, there are some slight differences in S&P 500 index funds.
For starters, ETFs are just like a stock that you can trade throughout the day, but mutual funds can only be bought at the end of the trading day. Index funds also have an advantage in the way they can reinvest the dividends paid by the stocks they hold. ETFs have to accumulate the cash over the course of the quarter while index funds can simply reinvest immediately. Finally, there are some minor differences in the way capital gains are taxed for each.
On the whole, though, for an average person looking for an easy way to start investing, the differences between an S&P 500 ETF and index fund are pretty minimal. If you plan to simply buy and hold the S&P 500, finding the lowest possible expense ratio or management fees is probably the most important consideration.
Why ETFs and Index Funds Are Good S&P 500 Investments
Both ETFs and index funds represent an approach to investing known as “passive management,” meaning that they don’t involve trying to actively pick which stocks to own and simply accepting the outcome of the broader market as a whole.
Not only is this a great way for a novice to start investing, there’s also plenty of evidence to suggest that even the most experienced market experts can’t actually beat the returns of the S&P 500 over time. Some 90 percent of mutual funds fail to outperform the S&P 500 after you consider the management fees they charge for carefully researching and selecting stocks.
So, more and more investors have taken the “if you can’t beat ’em, join ’em” approach and simply opted for the simple, low-fee approach offered by investing in the S&P 500 with ETFs or index funds.
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