Investor Facts: What Is The S&P 500?

Posted on August 10, 2016 at 10:25 AM PST by

The S&P 500 is a list of 500 stocks recognized as representative of large-cap companies in the United States.

Created by Standard & Poor’s (S&P), the S&P 500 Index of equities is weighted by market value and can change over time. It is meant to capture a large portion of the total value of the U.S. stock market, currently 80%, and thus serve as an economic indicator in its own right.

s&p 500

Market weighting means that larger companies make up a larger percentage of the index. As a result, if the largest companies see an increase in their stock prices, that will push up the total index disproportionately. A down day for the biggest stocks will push down the overall index.

In practice, the S&P 500 Index is a gauge of daily market performance. Investment funds use it as a benchmark for their own performance over time as well.

“Beating the market,” in trader-speak, means exceeding the return of the S&P 500 Index over a 12-month period or longer.

Why follow the S&P 500?

The S&P 500 is the standard benchmark for the biggest traded stocks in the U.S. economy. The market capitalization of these firms — the dollar value of shares held by investors — is at minimum $5.3 billion each and in many cases much more. At least half of a company’s stock has to be publicly traded to earn a spot on the S&P 500 Index.

Standard & Poor’s has been tracking stocks with indexes since 1923, but the S&P 500 itself was not created until 1957.

The S&P 500 Index is curated by a team of analysts and economists and is broadly recognized as the best way to answer the question, “How did the market do?” today, this month or over many years.

Companies can be removed from the S&P 500 for a number of reasons, such as bankruptcies and mergers, but often it’s the case that small companies become larger and big companies shrink as the economy changes.

For instance, telephone companies used to be the most heavily weighted in the index. Today it’s more often a technology company, an oil driller or a drug manufacturer.

Investing in the S&P 500

Investors should keep an eye on the S&P 500 but not to the point that “beating the market” is your primary goal. Instead, just owning an S&P 500 Index fund provides an annualized return very close to the market at an extremely low cost.

I say “close” because index funds are not free, although very nearly so. Moreover, investors today can construct entire portfolios using only index funds and capture a variety of asset classes at a very low total cost.

Diversification and periodic rebalancing in a portfolio helps to smooth returns and allows long-term savers to build account value steadily and with few surprises.