Understanding the S&P 500
The S&P 500 is a stock market index that tracks the stocks of 500 large-cap U.S. companies. It represents the stock market's performance by reporting the risks and returns of the biggest companies. Investors use it as the benchmark of the overall market, to which all other investments are compared.
As of Aug. 31, 2020, the S&P 500 had an average 10-year annual return of 12.66%.1 S&P stands for Standard and Poor, the names of the two founding financial companies.
The S&P 500 was officially introduced on March 4, 1957, by Standard & Poor. McGraw-Hill acquired it in 1966. The S&P Dow Jones Indices owns it now and that's a joint venture between S&P Global (formerly) McGraw Hill Financial, CME Group, and News Corp, the owner of Dow Jones.
How the S&P 500 Works
The S&P 500 tracks the market capitalization of the companies in its index. Market cap is the total value of all shares of stock a company has issued. It's calculated by multiplying the number of shares issued by the stock price. A company that has a market cap of $100 billion receives 10 times the representation as a company whose market cap is $10 billion. As of January 2021, the total market cap of the S&P 500 was $31.61 trillion.
A committee selects each of the index's 500 corporations based on their liquidity, size, and industry. It rebalances the index quarterly, in March, June, September, and December.
To qualify for the index, a company must be in the United States, have an unadjusted market cap of at least $8.2 billion. At least 50% of the corporation's stock must be available to the public. Its stock price must be at least $1 per share. It must file a 10-K annual report. At least 50% of its fixed assets and revenues must be in the United States. Finally, it must have at least four consecutive quarters of positive earnings.
The stock can't be listed on pink sheets or traded over the counter. It must be listed on the New York Stock Exchange, Investors Exchange, Nasdaq, or BATS Global Markets.
As of January 13, 2021, the 10 largest companies, with a weighted market cap, in the S&P 500 were:
Facebook Inc. A
Alphabet Inc. A (GOOGL)
Alphabet Inc. C (GOOG)
Johnson & Johnson
Berkshire Hathaway B
Proctor & Gamble
Visa Inc. A
As of Aug. 31, 2020, the S&P 500 sector breakdown included:
Information Technology: 27.5%
Health Care: 14.6%
Consumer Discretionary: 11.2%
Communication Services: 10.9%
Consumer Staples: 7.0%
Real Estate: 2.8%
S&P 500 vs. Other Stock Market Indexes
The S&P 500 has more large-cap stocks than the Dow Jones Industrial Average. The Dow tracks the share price of 30 companies that best represent their industries. Its market capitalization accounts for almost one-quarter of the U.S. stock market. The Dow is the most quoted market indicator in the world.5
The S&P 500 has fewer technology-related stocks than the Nasdaq. As of January 2021, 57% of Nasdaq allocations were in information technology compared to 23% for the S&P 500 at that time.6
Despite these differences, all these stock indexes tend to move together. If you only focus on one, you will still be able to understand how well the stock market is generally doing. In other words, you don't have to follow all three.
How to Use the S&P 500 to Make Money
Although you can't invest in the S&P, you can mimic its performance with an index fund. You could also buy shares of stocks that are in the S&P 500.
You should use the S&P 500 as a leading economic indicator of how well the U.S. economy is doing. If investors are confident in the economy, they will buy stocks.
Since the S&P 500 only measures U.S. stocks, you should also monitor foreign markets. That includes emerging markets like South Africa and India. It may also be a good idea to keep 10% of your investments in commodities, like gold. They tend to hold value longer when stock prices drop.
Besides following the S&P 500, you should also follow the bond market. Standard & Poor's also gives bonds credit ratings. When stock prices go up, bond prices go down. There are many different types of bonds. They include Treasury bonds, corporate bonds, and municipal bonds. Bonds provide some of the liquidity that keeps the U.S. economy lubricated. Their most important effect is on mortgage interest rates.
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Article partially appeared on thebalance.com
Credit: thebalance.com, S&P 500 Index, NYSE
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