What is the S&P 500 Index? Everything You Need to Know
The S&P 500, also known as the Standard & Poor's 500 Index, stands as a barometer for the U.S. equity market, encompassing 500 of the leading publicly-traded American corporations. Curiously, the index consists of 503 entities due to the dual share classes of three of its components.
Launched in 1957 by the renowned credit rating entity, Standard & Poor's, this index has evolved to become a benchmark for the performance of prime American stocks. It serves as a reflection of the broader stock market and, in many ways, the U.S. economy's health.
Today, to be a component of this esteemed index, a company must meet stringent criteria, including being U.S.-based and publicly traded, with adequate liquidity and a minimum 10% public float.
The Essence of the S&P 500
This index stresses market capitalization, adjusting company market caps by the amount of shares available to the public. Notably, it doesn't represent the top 500 companies by market cap alone; there are additional criteria involved in its formation.
Institutional investors, finance professionals, and even casual investors turn to the S&P 500 because of its comprehensive representation of the U.S. large-cap domain. This makes it an ideal gauge for the overall health of the U.S. equities market.
Which Stocks are in the S&P 500? The Top Holdings
As mentioned earlier, the S&P 500 holds around 500 stocks, but which ones are they? Well, below are the top 10 based on their weighting in the index, taken from the VOO ETF, which tracks the S&P 500. As you can see below, AAPL and MSFT are the top 2 holdings, which should come as no surprise.
VOO’s top 10 holdings as of September 25, 2023. Source: Vanguard
Also, the image below shows how much exposure to each sector you’d get from investing in VOO. Information technology has the biggest weighting at 28.2% as of September 25, 2023, meaning that for every $100 you invest, $28.20 would go toward tech stocks.
Diving Deeper: The Index's Mechanics
The S&P 500 employs a market-cap weighting approach, attributing a higher allocation percentage to firms with more substantial market capitalizations. To understand its workings:
The market cap for every entity is obtained by multiplying its current stock price with its outstanding shares.
The combined market cap of all the index's entities gives the total market cap for the S&P 500.
The weight of each component in the index is determined by its market cap relative to the total index market cap.
Beyond the S&P 500: A Look at Other Indices
The S&P 500 isn't alone in its representation. It's part of the expansive S&P Global 1200 series. Others in the family include the S&P MidCap 400, reflecting mid-sized corporations, and the S&P SmallCap 600, focusing on smaller firms. These three collectively provide a snapshot of about 90% of U.S. market capitalization under the umbrella of the S&P Composite 1500.
Key Differences: S&P 500 and Its Rivals
Dow Jones Industrial Average (DJIA): This index, although renowned, includes only 30 significant equities and is price-weighted. The S&P 500, with its broader 500-stock representation and market-cap weighting, is typically favored by institutional investors. You can invest in the Dow Jones via the DIA ETF.
Nasdaq: While Nasdaq is a global electronic trading platform, it boasts several indices. The S&P 500 and various Nasdaq indices can overlap, with stocks being part of both. You can invest in the Nasdaq 100 index through the QQQ ETF.
Russell Indexes: Like the S&P indexes, Russell's are mostly market-cap-weighted. However, their construction differs, with Russell employing formulas for stock inclusion and the potential for overlap in their style indices. A popular index is the Russell 2000, which is made up of the 2,000 smallest stocks in the Russell 3000 index. It’s essentially a small to mid-cap ETF. You can invest in the Russell 2000 via the IWM ETF.
Navigating the S&P 500's Limitations
A potential drawback of market-cap-weighted indices like the S&P 500 is the risk of overvaluation. If an overvalued stock holds significant weight in the index, it might inflate the index's overall value. Hence, the growing popularity of equal-weighted indices where each stock's movement equally impacts the index.
Investing in the S&P 500
While one cannot directly invest in the S&P 500, many funds and ETFs, like the Vanguard 500 ETF (VOO), are designed to track it with minimal deviations. These vehicles offer an accessible route for investors aiming to align with the S&P 500's performance. VOO can easily be bought on a brokerage account by just searching the ticker.
Final Thoughts
Regarded as a cornerstone of the U.S. equity landscape, the S&P 500's wide representation makes it an invaluable tool for any investor. Encompassing sectors from tech to banking, this index offers a panoramic view of the U.S. market economy's performance.
