What is the S&P 500? You’ve probably heard it mentioned dozens – if not hundreds of times. Do you know what it is though? Financial experts seem to assume that everyone understands so they don’t take any time to say what that actually means. Today we’ll take a few minutes to clarify this term because understanding what the S&P 500 is can have a large impact on your overall investing.
What is the S&P 500?
The “S&P” part of the term actually stands for Standard and Poor’s. Standard and Poor’s is a 150+-year-old company that performs research and analysis on companies, entire industries, and related publicly traded stocks.
One popular service they provide is credit ratings on a large variety of entities. But what they are best known for – at least by “normal people” – is the S&P 500 index. That index is a list of 500 of the largest publicly traded American companies. It’s a well-diversified group representing quite a few different industries across the entire corporate landscape.
Because of the wide range of companies, and their sizes on the stock market exchanges, this index is what is often referenced when someone says “the market”. Was “the market” up last year? That very likely refers to the aggregate direction of this group of stocks. Some may be up, and some may be down. When more increase in value than decline, that is often considered that “the market” is up.
I like how Investopedia sums it up:
“The S&P 500 is widely regarded as the most accurate gauge of the performance of large-cap American equities. While the S&P 500 focuses on the large-cap sector of the market; it is considered representative of the market because it includes a significant portion of the total value of the market.”
What does large-cap mean?
If you don’t know what “large-cap” means, that paragraph might be a little confusing. Large-cap is short for companies with large capitalization. It essentially means publicly traded companies whose total value of their stock is worth more than $10 billion dollars. A mid-cap company has a total stock value of between $2 and $10 billion. A small-cap company would have a total stock value of under $2 billion dollars. $2 billion may not sound “small” – at least it doesn’t to me – but when comparing the landscape of American companies, that actually is a comparatively small number.
Investing in the S&P 500
If you have faith in the overall health and future of the American market, you might want to consider investing in the companies that make up the S&P 500 index. There are two main ways to do this: 1) Buy shares of stock in every single company in the index; 2) Buy shares of a fund that tracks the companies in the index.
There are both mutual funds and exchange-traded funds (ETFs) that track the S&P 500 index. Investors can purchase shares in this single fund and then the fund purchases shares in the underlying companies. It makes investing in an index like the S&P 500 super-easy.
Should you invest in the S&P 500 index?
Of course, everyone’s situation is a bit different, but in general, investing in an S&P 500 index fund is a great option for most investors. Holding a diversified portfolio is recommended, and the S&P 500 is diversified by definition. Of course, you might want to further diversify, as we have personally, depending on your risk tolerance and investing goals.
Warren Buffett is one of the wealthiest Americans and generally considered one of the most successful investors of all time. He has made multiple statements endorsing the action of investing in an S&P 500 index fund. One of his quotes states “Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund.”
How are the S&P 500 historical returns?
You’ve likely heard that “the market” has returned about 10% per year on average since inception. This statistic is directly related to the S&P 500 index. No one can say for sure what will happen in the future, but through lots of ups-and-downs, over 100+ years, the S&P 500 index has returned about 10% per year on average.
I’m a big fan of the American economy and therefore the S&P 500 index. Personally, we hold a decent amount of money directly in an S&P 500 index and I believe it is worth at least consideration by the average investor.
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