What is the S&P 500 Index?
The S&P 500 Index, short for the Standard & Poor’s 500, is a stock market index that tracks the stocks of 500 large-cap U.S. companies.
This benchmark is considered one of the best trackers of the U.S. stock market and its performance. The index focuses on the largest companies that meet specific inclusion criteria and cover approximately 80% of the total market capitalization of U.S. equities.
Overview of the S&P 500
Here are some key facts about the S&P 500 Index:
- It includes 500 of the largest U.S. companies in leading industries, weighted by their free-float market capitalization.
- To be eligible, companies must meet minimum liquidity, public float, and fundamental requirements.
- The index covers about 80% of the value of the American equities market by market capitalization.
- It is widely regarded as the best gauge of large-cap U.S. stock market performance.
- The index includes companies within 11 major economic sectors, excluding transportation and utilities.
- Its performance is often used as a proxy for the state of the US economy and investor sentiment.
- The composition and weightings of the index evolve over time. Companies can be added or dropped by the Index Committee.
- It is a float-adjusted, market-cap-weighted index. This means that more weight is assigned to companies with higher valuations.
- The S&P 500 was formally launched in 1957 by Standard & Poor’s. The index succeeded earlier versions that tracked 90 and 233 stocks, respectively.
- The index is owned, managed, and published by S&P Dow Jones Indices company, a joint venture between S&P Global, CME Group, and News Corp.
- The S&P 500 Index is rebalanced quarterly. The weights of each individual component are readjusted based on the fluctuation that their market cap has experienced during that period relative to the aggregated value of all the companies that make up the benchmark.
How is the S&P 500 Calculated?
Unlike some other popular indexes like the Dow Jones Industrial Average, the S&P 500 is weighted by free-float market capitalization rather than share-price weighting.
The value of the S&P 500 Index is calculated by:
- Adding up the free-float market capitalization of each component company. Free-float market cap only includes publicly traded shares, not locked-up shares.
- Dividing the total market cap by a proprietary index divisor. The divisor ensures continuity and comparability in the index over time. It is adjusted for corporate actions that affect market caps, like stock splits or spinoffs.
As a result of market-cap weighting, larger companies like Apple and Microsoft, which are assigned elevated individual weights, have a significant influence on the index’s performance compared to smaller companies.
The S&P 500 essentially tracks the aggregate performance of the 500 top American stocks.
S&P 500 Weighting Example
The S&P 500 is a market cap-weighted index, meaning that each component’s weight is determined based on its individual market capitalization relative to the aggregated market cap of all the components that make up the benchmark.
Here is an example of how the weighting for Apple (AAPL) stock would calculated within the S&P 500:
- As of October 2023, Apple has approximately 15.6 billion shares outstanding, trading at around $177 per share.
- Apple’s market capitalization is calculated by multiplying its share price by shares outstanding: $177 x 15.6 billion = $2.8 trillion.
- The total market capitalization of the S&P 500 is approximately $38 trillion.
- To determine Apple’s weighting, divide its individual market cap by the S&P 500 total market cap: $2.24 trillion / $35 trillion = 7.4%
Therefore, Apple comprises approximately 7.4% of the total value of the S&P 500 due to its large market cap.
- If Apple’s share price rose 10% to $195, its new market cap would be $3 trillion. This would increase its weighting in the S&P 500.
- Conversely, if its share price fell 10% to $159, its market cap would fall to $2.5 trillion, decreasing its index weighting.
How to Invest in the S&P 500?
Since the S&P 500 is an index, it is not possible to directly invest in it.
However, investors can get exposure to the index via these vehicles or methodologies:
- Purchase Shares of the 500 Underlying Companies Directly: This is the most inconvenient and complex way to invest in the index, as a lot of transactions must be executed, and the weight of each component will have to be manually rebalanced periodically to track the index’s performance accurately.
- Invest in Index Mutual Funds or ETFs that Track the S&P 500: Some examples of exchange-traded funds (ETFs) and mutual funds that track this benchmark include the Vanguard 500 Index Fund and SPDR S&P 500 ETF. These investment vehicles provide exposure to the index and replicate its performance. They can be easily bought, and investors will not have to worry about rebalancing or including/excluding components as fund managers will perform this task.
- Trade S&P 500 Futures Contracts or Options: Traders will typically rely on these instruments to speculate on the index’s price movements. Operating with these derivatives requires some advanced skills and knowledge about the intricacies of how they are priced and other similar dynamics.
Many investors tend to incorporate vehicles that mimic the performance of the S&P 500 in their portfolios due to the positive results that the index has had for multiple decades.
Most studies show that the average gain produced by the S&P 500 in the past 60 to 70 years stands at around 10%. That said, past performance is not a guarantee of future results.
The S&P 500 is also a common benchmark used to evaluate the performance of active investment managers. Managers who fail to beat the index’s results for long periods are considered poor performers considering the additional risk they take compared to the diversified nature of the index.
S&P 500 Sector Composition
The 500 companies within the S&P 500 belong to 11 different economic sectors or Global Industry Classification Standard (GICS) sectors.
This ensures that the index’s performance can be taken as a relatively accurate representation of the U.S. economy. The 11 sectors and their approximate weights as of 29 September 2023 are:
Information technology and healthcare stocks make up the two biggest sectors, reflecting the growth of tech companies over the past decades.
Companies are assigned to sectors based on their core business activity. The index committee may switch the industry that individual companies belong to depending on how their business models evolve over time.
S&P 500 vs. Other Major Indexes
The S&P 500 is often compared to other major stock indexes. Some key differences include:
- Dow Jones Industrial Average: The Dow tracks just 30 large blue chip stocks and uses price-weighting. The S&P 500 tracks the 500 largest companies by market cap, covers more industries and uses market-cap weighting.
- Nasdaq Composite: The Nasdaq includes over 3,000 stocks listed on the Nasdaq stock exchange. It has greater exposure to tech and growth stocks than the S&P 500, which aims to be representative of the broader market.
- Russell 2000: The Russell 2000 tracks 2,000 small-cap U.S. stocks, while the S&P focuses solely on mega and large caps. The Russell provides insight into the performance of smaller public companies.