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You have probably heard of the Standard & Poor’s 500 (S&P 500) index. But do you know what it is? Many people believe it is a fund. But it is only a stock market index. And there are many funds available that track the performance of this index. There are many interesting facts about this index. If you have chosen to invest in this stock market index, you may want to learn more about it.
For instance, did you know it does not track the 500 largest companies in the United States? It tracks 500 large companies from the U.S. stock market, not necessarily the largest. Indeed, the index is not managed by a single formula or computer. A committee of humans makes the decision to include or remove a company from the index.
In this article, we will see what is inside the S&P 500 index. We will also see how the committee manages the index and updates it over the years. Finally, I will also describe how to invest in this index.
The S&P 500 Index
The Standard & Poor’s 500 (S&P 500) index tracks 500 large companies in the United States stock market. It is among the most famous indexes, along with the Dow Jones Industrial Average (DJIA) and the NASDAQ. His name comes from the fact that the Standard & Poor’s company manages it.
Standard & Poor’s is an indexing company that manages several indexes. It is a very old company, founded in 1860. The S&P 500 index started its life under the name of the Composite Index in 1923. At that time, it was only tracking a few stocks. In 1926, it was first increased to track 90 stocks. Only in 1957 was it expanded to 500 stocks, becoming the S&P 500 index.
To be a bit more precise, the index is managed by the S&P Dow Jones Indices joint venture. It is part of the broader S&P Global company. It is the same company that is managing the Dow Jones Industrial Average (DJIA), another very famous stock market index.
Selection of companies
A committee of people selects the components of the index. The selection is not as easy as choosing the 500 largest companies in the U.S. stock market. There are requirements on eight points for each company in the index: market capitalization, liquidity, domicile, public float, sector classification, financial viability, and time on the public market.
Here are a few of the most essential requirements for inclusion in the index:
- The company must have a market capitalization greater than 6 billion dollars.
- The price of the share must be higher than one dollar. This rule excludes penny stocks from the index.
- The shares must have a trading volume of at least 250 thousand per month.
The committed adjusts the index several times yearly to reflect changes in the stock market and the companies making the index. For instance, there have been four changes in the first two months of 2019:
- On January 2, Dominion acquired SCANA. SCANA was removed from the index, and First Republic Bank (FRC) was added.
- On January 18, PG&E Corporation filed for bankruptcy and was removed from the index. Teleflex took its place in the index.
- On February 15, ECA bought Newfield Exploration Co (NFX), which was removed from the index. This event made a place for Atmos to join the index.
- On February 27, Wabtec Corporation (WAB) acquired a large company and became large enough to join the index. This led Goodyear Tire & Rubber company out of the index.
As you can see, the index is far from being set in stone. It changes many times each year. Since there are always 500 companies in the index, each change removes a company from the index and adds a new one.
Companies in the S&P 500 Index
You may think that the index tracks the performance of 500 shares. But it is tracking 505 shares. Why is that? The reason is, in fact, simple, some of the 500 companies in the index have different kinds of shares. For instance, Alphabet (the parent company of Google) offers two classes of shares with different voting rights. The index includes both kinds of shares for Alphabet. And it does the same for other companies from the index, resulting in 505 shares now.
Such as most of the indexes followed these days, the S&P 500 index is market-capitalization-weighted. It means that the bigger a company is, the more significant part of the index it will make. The total value of all the shares of the company is taken into account as the size of the company. At the time of this blog post, here are the five biggest companies in the index:
- Microsoft Corporation: 3.53%
- Apple Incorporated: 3.29%
- Amazon: 3.09%
- Facebook Incorporated: 1.75%
- Berkshire Hataway: 1.69%
Even with 500 companies, the first five companies already make up around 13% of the index. And the first ten companies make up 21% of the index. This imbalance is because of market capitalization weighting and the huge discrepancies in the U.S. stock market.
There are many alternative versions of the S&P 500 index.
The S&P Midcap 400 index, also known as the S&P 400 index, tracks the performance of medium capitalization (mid-cap) companies from the U.S. stock market. Its companies are just a bit smaller than the smallest company in the S&P 500 index.
The S&P Smallcap 600 index, also known as the S&P 600 index, tracks the performance of, you guessed it, small-capitalization (small-cap) companies from the American stock market. Its companies are smaller than the smallest company from the S&P 400 index.
Interestingly, these indexes can be combined. The S&P 400 plus the S&P 600 index form the S&P 1000 index. And together, the S&P 1000 index and the S&P 500 index form the S&P 1500 index. Finally, the S&P 500 and the S&P 400 are the same as the S&P 900. It seems they thought of everything!
All these funds are also existing in two alternative variants. Investors often split them into their Value and Growth subsets of companies. These subsets are based on the style of each company and its related investment style. Some people invest because the value of the share is below the real value of the company. This style of investing is what we call Value Investing. And some people prefer to focus on companies that are growing rapidly. We call them Growth companies, hence the name of the index variant.
S&P 500 ETFs
Since the S&P 500 is only an index, you cannot directly invest in it. You could track the index yourself by buying all the companies from it. However, this would be inefficient and almost impossible unless your net worth is big. Therefore, you must invest in the index through a mutual fund or an Exchange Traded Fund (ETF). Since most ETF providers also provide an equivalent mutual fund and vice-versa, we will look only at the ETFs tracking this index.
The S&P 500 index is one of the most popular indexes that exist. As such, many funds are tracking this index. You will find many ETFs for this particular. Here are the three main ETFs tracking this index:
- SPDR S&P 500 ETF (SPY): This fund manages a total of 263 billion dollars. The ETF has a TER of 0.09%.
- iShares Core S&P 500 ETF (IVV): This ETF manages 160 billion dollars. It has a TER of 0.04%.
- Vanguard S&P 500 ETF (VOO): Although the smallest of the three, VOO still manages over 100 billion dollars. It has a TER of 0.04%.
These three ETFs are very large, more than enough. Given their TER, I would choose the iShares ETF (IVV) or the Vanguard ETF (VOO). They are both very good funds, and I do not think it will make a big difference in the long-term, which ETF you choose. I would go with VOO since I like Vanguard’s philosophy. But again, this is a personal choice. There is nothing wrong with IVV.
I think that covers the S&P 500! It is a popular index that includes about 90% of the United States stock market. It contains only large or very large companies. The S&P 500 index is quite old. It is more than 60 years old in its current form.
I prefer the index to be decided by formula rather than a committee. However, over the years, this has worked pretty well. I do not think this will cause an issue in the future. I am currently investing in this index via the Vanguard S&P 500 index. If you want to invest in the U.S. stock market, it is a good choice of index.
What do you think of this index? Is it part of your investment portfolio? Do you know anything else interesting about the S&P 500?
If you want to invest in more than 500 companies, you can learn about the Russell 3000 index. If you want to compare indexes, I also wrote a guide about comparing different stock market indexes.
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