What is the S&P 500?
A market index is an investment portfolio that aims to represent a certain segment of the stock market. Some market indexes include the Dow Jones Industrial Average (DIJA), the Nasdaq Composite Index, and, of course, the Standard and Poors 500 index, otherwise known as the S&P 500. The S&P 500 tracks the performance of about 500 high-value companies in the United States and therefore aims to represent the performance of the U.S stock market and overall U.S. economy. Since so many companies are included in the S&P 500 index, many consider it a great way todiversify an investment portfolio.
What companies are included in the S&P 500?
A committee evaluates companies quarterly and includes in the S&P only those companies that fulfill a long list of criteria. For example, companies included in the S&P must be based in the U.S., listed on a U.S. exchange, offer stock, and have a historical record of positive earnings. But one of the better-known pre-requisites is that the company must have a market capitalization of at least $8.2 billion. Market capitalization or market cap is a fancy way of saying the value of a companys outstanding shares. Mathematically, the market cap is known as the number of shares outstanding multiplied by the price of a single share. Due to this criterion, the S&P 500 is known for representing only large market capitalization or large-cap companies. Also, the S&P 500 is considered a capitalization-weighted index. In simpler words, the companies with the largest market cap have a larger effect on the overall value of the S&P 500.
A lot of well-known companies such as Apple, Amazon, and Microsoft are included in the S&P 500. However, popularity is not a requirement and lesser-known companies are also included. Regardless, the companies within the S&P aim to represent eleven business sectors: Energy, Real Estate, Utilities, Communication Services, Materials, Industrials, Consumer Staples, Health Care, Financials, Consumer Discretionary, and Technology.
History of the S&P 500
Despite S&P 500 popularity today, the index fund was not the first of its kind. The Dow Jones Industrial Average (DIJA) index predates the inception of the S&P 500 by many years. DIJA was created in 1896 and comprised 12 companies representing the industrial sector. The concept of the S&P 500 did not emerge until 1926, when the Standard Statistics Company created an index consisting only 90 stocks. At the time, it was called the Composite Index. In 1941, Standard Statistics merged with Poors Publishing to become Standard & Poors and established itself as a company specializing in providing indexes and market data. Then, in 1957, Standard & Poors formalized the S&P 500 index we see today. The index included about 500 companies compared to the original 90.
Over time the S&P 500 has accurately reflected the U.S. economy; the index saw spikes in value during economic booms and dips during recessions. Since its inception, the S&P has provided higher returns than other major assets and is seen as a safer investment by the finance community.
Investing in the S&P 500
Most major brokerages and investing platforms offer the opportunity to invest in an S&P 500 index fund, including Public. SPDR S&P 500 ETF Trust (SPY), Vanguard S&P 500 ETF (VOO), and iShares Core S&P 500 ETF (IVV) are just a few examples of S&P 500 funds available for investors. People often invest in indexes that track the S&P 500 because the funds represent a diverse selection of large-cap companies. An index fund that includes stock from various industries and sectors is often seen as less risky because its success isnt reliant on a single company or trend. Risk-averse or first-time investors may find an S&P 500 index to be a good place to start their investing journey.
Average returns of the S&P 500
As mentioned, the S&P 500 follows the same patterns of the U.S. economy and therefore experiences periods of growth and depression. For example, after the financial crisis in 2008, the S&P saw a decline in value of about 37%. On the contrary, in 2019 the S&P saw an increase in value of about 31%. That being said, from its inception in 1957 up until the end of 2019, the index has seen an annualized average return of about 10%. This tends to be higher than the returns of other assets, but like other investments, market timing is everything; if someone invests at the wrong time the returns may not be so favorable.
Bottom line
The S&P 500 includes many large-cap companies from various business sectors that fulfill a very specific list of criteria. Because the S&P represents so many different industries and high-value companies, it has historically been successful in reflecting the various ups and downs of the U.S. economy and stock market. While the performance of the S&P varies from year to year, the average annualized return since its inception in 1957 is 10%. While the S&P 500 is seen as a good investment for someone who is more risk-averse, investing in the S&P is not risk-free. Timing is everything in the investing world, and this is no exception.
