What exactly is the S&P 500? And how do you invest in it?

May 14 2021, 12:46 am

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Still new to the world of investing? If the only thing that comes to mind when you hear the abbreviation S&P is salt and pepper, we’re here to help.

Unlike choosing individual stocks, the S&P 500 index is a diversified approach to investing that gives investors access to the 500 US companies with the biggest market cap (the market value of a publicly-traded company’s outstanding shares).

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Holding an investment in the S&P 500 over a long time period is often said to give better results than picking individual stocks. And it’s incredibly popular amongst both beginners and seasoned investors, as it provides a passive way to diversify investments across a broad range of the best-performing companies.

It’s no wonder over $11.2 trillion is currently being invested into the index or that Warren Buffett is one of its biggest fans. The Oracle of Omaha has been quoted as saying, “for most people, the best thing to do is own the S&P 500 index fund.”

What exactly is the S&P 500?

The S&P 500 dates back to 1957 when it was created by an investment information service called Standard & Poor—which is where it gets its (ironic) abbreviation from. Today the index consists of 505 stocks that are reviewed once a quarter by an investment committee. To make it into the S&P 500, companies need to meet certain standards in market size, liquidity, and group representation.

The top 10 companies currently listed on the S&P 500 are Apple Inc. (AAPL), Microsoft Corporation (MSFT), Amazon.com Inc. (AMZN), Facebook Inc. (FB), Alphabet Inc. Class A (GOOGL), Alphabet Inc. Class C (GOOG), Berkshire Hathaway Inc. (BRK.B), JPMorgan Chase & Co. (JPM), Tesla Inc (TSLA), and Johnson & Johnson (JNJ), in ranking order.

Unlike mutual funds that use brokers to try to outperform the index through active trading, the S&P 500 lets investors diversify their portfolio by passively buying shares of a broad array of companies. It also allows users to not have to independently buy 505 different stocks at the same time—because let’s be real, no one has time for that.

How do you invest in the S&P 500?

This brings us to our next point—if you’re not going to be making 505 separate transactions, how do you actually go about investing in this index? Well, as an index is merely a measure, unfortunately you can’t directly invest in it. But luckily, index funds and ETFs (exchange-traded funds) exist that mimic the index.

ETFs and index funds are similar but have slight differences in fee structures and when you can buy and sell your fund. For example, index funds can only be bought for the price set at the end of the trading day, whereas an ETF can be bought and sold throughout the day and ETFs usually require lower minimum investments than index funds. You’ll want to read into the fine print before choosing exactly which one to go for.

Another option to consider is whether you’ll want to go for a cap-weighted or equal-weighted investment. If, for example, Microsoft shares take a huge dive, opting for a cap-weighted investment means your investment will be impacted more than companies ranked lower on the index. Whereas an equal-weighted investment will reflect the share prices of the index as a whole.

Are there any downsides to the S&P?

Now you know what the S&P 500 is, and how to invest in it, you might be wondering if it all sounds too good to be true.

Well, although the index’s strength lies in its preference for large-cap companies, depending on how you look at it, and what your investment preferences are, this could be viewed as a weakness.

By only including large-cap companies, the index excludes some of the smaller and mid-cap companies out there. So, if you’re mainly interested in holding shares of emerging companies and startups, then the S&P isn’t your best option.

But if you’re patient to see returns build up over the long-term, are interested in a passive investment—where you don’t have to constantly panic over whether you should have held or sold—and want to diversify your portfolio, then the S&P 500 is a fantastic investment option.

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