What Is the S&P 500 Index and How Does It Work?
The Standard & Poor’s 500 index is a collection of U.S. equities across a broad range of industries. The Vanguard S&P 500 index fund, one of the most popular ways to invest in the index, holds more than $600 billion in investor funds — a testament to the index’s popularity and success.
Although most investors likely know that the S&P 500 is one of the major market averages, many might not fully understand what the S&P 500 actually is, or how it is created and maintained.
What is the S&P 500 index? What is S&P 500 stock — and how do you buy it?
Keep reading to learn everything you should know about investing in the S&P 500 index.
What Is the S&P 500?
Standard & Poor’s provides investors and institutions with financial data and analytical information on global markets. So, while many people might automatically connect “S&P” to the S&P 500, it’s actually a company with a wealth of other information.
The S&P 500 is one of a handful of indexes developed by a division of the company known as the S&P Dow Jones Indices. The intent of the index is to reflect the performance of the broader economy.
A stock index is a collection of stocks meant to represent a certain segment of the overall market. Countless stock market indexes exist, tracking everything from oil stocks and transportation companies to small, medium and large businesses. Each index consists of common stocks from the particular industry or market group the index represents.
The S&P has both benefits and drawbacks as an investment vehicle. It’s an easy way to diversify and match the market because it includes stocks from a broad range of industries, but it must invest within its set criteria as with any index fund. This limitation makes it less flexible than non-index funds.
How Does the S&P 500 Work?
The stocks in the S&P 500 represent more than 80% of the total value, or market capitalization, of the entire U.S. equity market. As a result, the S&P 500 is essentially a proxy for the overall market. Just keep in mind that it’s strictly a stock market index for the biggest companies. To even qualify for inclusion, a company must have a market capitalization of nearly $10 billion.
S&P 500 Price
The price of the S&P 500 is determined through a process known as weighted average market capitalization. Market capitalization is calculated by multiplying the shares a company has outstanding times the current market price. For example, if a company has 10 million shares outstanding and a $45 share price, its market cap is $450 million.
To get a weighted average market capitalization, this figure is multiplied by the percentage “weight” a company has in the index. For example, if the entire S&P 500 is worth $10 billion and one stock has a market cap of $100 million, it has a 1% weight in the average.
Top Companies in the S&P 500
The largest stocks in the S&P 500 index include some of the most recognizable brands and companies in the world. Following is a list of the biggest companies in the index ranked by market capitalization. Some companies might be listed more than once because of their different share classes.
|Company||Percentage of S&P||Stock Price|
|Facebook Inc. Class A||2.07%||$269.45|
|Alphabet Inc. Class A||1.66%||$2,075.39|
|Alphabet Inc. Class C||1.60%||$2,083.51|
|Berkshire Hathaway Inc. Class B||1.42%||$39.91|
|Johnson & Johnson||1.30%||$166.27|
|JPMorgan Chase & Co.||1.22%||$139.58|
How Does a Company Qualify for the S&P 500?
The S&P 500 index consists solely of large-cap stocks. Beyond that classification, however, the index does not adhere to one particular investment style. It includes both value stocks, which might pay a dividend and have a low valuation; as well as growth stocks, which often have high valuations and pay no dividends.
Here are the requirements a company must meet before being included in the S&P 500:
- Based in the U.S.
- Market cap of at least $9.8 billion
- Highly liquid
- Public float of at least 10% of shares outstanding
- Positive earnings during the most recent quarter and the sum of its trailing four consecutive quarters
Returns and Limitations of the S&P 500
It’s hard to judge an investment vehicle without raw numbers. So what is the S&P average annual return?
Over the past 90 years, the average annualized total return for the S&P 500 is 9.8%, though returns can differ greatly from one year to the next. The good news is, over the long term stocks provide the highest average performance among major asset classes. The S&P has consistently produced strong returns over the decades.
But there are some limitations. The S&P 500 must follow specific guidelines, limiting its ability to include high-performing stocks that are outside of its criteria. And although the S&P 500 is very broad with its investments, there’s always the possibility of a poor selection that underperforms the general stock market averages.
- What’s the S&P 500 all-time high? The index has been climbing to record highs in 2021, hitting 3917.72 on Feb. 9.
- What is the S&P 500 benchmark? The S&P 500 operates as a benchmark against which the stock market is compared.
- What is an S&P 500 futures contract? According to the U.S. Securities and Exchange Commission, a futures contract is “an agreement to buy or sell a specific quantity of a commodity or financial instrument at a specified price on a particular date in the future.” You can buy S&P 500 futures contracts on the Chicago Mercantile Exchange.
- What is the S&P 500 dividend yield? The long-term average dividend yield of the S&P 500 is 1.57%.
How To Invest in the S&P 500
Now that you understand what the S&P 500 means and how it operates, how can you invest in it?
S&P stock can be purchased through funds such as the Vanguard 500 Index Investor Shares (VFINX) or Fidelity 500 Index Fund (FXAIX), as well as at many other investment firms. If you want to invest in the S&P through one of these companies, here are some steps to help you decide which vehicle works best:
- Determine which S&P 500 index fund you want to purchase.
- Look at the initial minimum investment for the fund and its fees.
- Determine the amount that you want to invest in the index fund.
- Purchase your index fund through an existing retirement account or open a new account with a company such as Vanguard or Fidelity.
What’s an S&P 500 index fund? It’s a fund composed of the S&P 500 index, packaged so you can buy and sell it. These index funds can be easily bought and sold through an existing retirement account or investment portfolio.
S&P 500 Key Takeaways
The S&P 500 has a strong performance record. As you consider investing in the index, keep these points in mind:
- Investing in the S&P 500 index makes it possible to invest in a multitude of stocks at once.
- Index funds are intended to provide a diversified portfolio of stocks that are managed by another party.
- Investors can purchase S&P 500 index funds through companies such as Vanguard and Fidelity.
Ultimately, if you’re in it for the long haul, your investment in the S&P 500 should pay off nicely.
This article has been updated with additional reporting since its original publication.
Data is accurate as of Feb. 10, 2021, and is subject to change.
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