What Exactly Is the S&P 500 Index?

Published Jan. 25, 2022
What exactly is the S&P 500 Index?

S&P 500 index funds are a great method to acquire diversified exposure to the U.S. stock market’s heartland. These passively managed funds invest in large-cap equities, which account for around 80% of the entire value of the US equity market.

There are many index funds that track the S&P 500, but these three have ultra-low expense ratios, which means more of your money stays in the fund and earns you higher returns. Furthermore, all three funds closely match or outperform their benchmark index’s historical performance.

What is SP 500?

The S&P 500 index was established in 1957, but its origins can be traced back to the 1860s. The Standard Statistics Company, founded in 1968, and Poor’s Publishing, founded in 1868, merged to form Standard & Poor’s.

Standard & Poor’s was created in 1941 when the two corporations united their expertise in financial data reporting and publishing. Standard & Poor’s merged with Dow Jones in 2012 to become S&P Dow Jones Indices, a branch of S&P Global.

The S&P 500 Index includes 500 of the largest publicly traded firms in the United States, with a focus on market capitalization. The S&P is a float-weighted index, which means that the index’s market capitalizations are adjusted for the number of shares available for public trading.The S&P 500 is widely regarded as one of the best measures of significant U.S. stocks, if not the whole equities market, due to its breadth and diversity. Because the S&P 500 is an index, you can’t invest directly in it, but you can invest in one of the numerous funds that track its composition and performance.

What are stock market indexes?

A stock market index reflects how investors perceive the state of the economy. An index compiles data from a wide range of businesses in many industries. When all of this information is combined, it creates a picture that allows investors to compare current price levels to previous price levels in order to calculate market performance. Some indices concentrate on a narrower segment of the market. The Nasdaq index, for example, closely tracks the technology sector.

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Rising Popularity of Index Funds

For a variety of reasons, index funds based on major indices are popular. These funds provide a strong long-term return, are well-diversified, and are a low-risk option to invest in equities.

(i) Excellent Returns
Major indices, like all equities, will fluctuate. However, over time, indexes have delivered good returns, such as the S&P 500’s long-term annual return of around 10%. That doesn’t imply index funds make money every year, but that has been the average return throughout time.

(ii) Diversification
Index funds are popular among investors because they provide quick diversification. Investors can buy a diverse range of businesses with a single investment. A share of an index fund based on the S&P 500 gives you ownership in hundreds of firms, whereas a share of the Nasdaq-100 fund gives you exposure to about 100.

(iii) Lower Risk
Investing in an index fund is less risky than holding a few individual stocks because they’re diversified. That’s not to say you won’t lose money or that they’re as safe as a CD, but the index will often move less than an individual stock.

(iv) Low Cost
Because index funds have a low expense ratio, they may charge relatively little for these services. You may pay $3 to $10 per year for each $10,000 you have invested in larger funds. In fact, one of the funds listed above has no expense ratio. One of the most crucial aspects of your total return when it comes to index funds is the cost.

How to Choose an S&P 500 Index Fund?

Because there are so many S&P 500 index funds on the market, it’s critical to keep a few criteria in mind when selecting one for your portfolio. Consider the following:

The cost-to-income ratio. Expense ratios, which represent the fees you pay for the upkeep of your fund, should be minimal because index funds are passively managed. Because all S&P 500 index funds perform identically, the amount you spend in fees becomes crucial when choosing a fund.

Since there are so many S&P 500 index funds on the market, it’s critical to keep a few criteria in mind when deciding which one is suitable for your portfolio. Consider these points:

(i) Ratio of costs to revenues
Expense ratios, which represent the costs you pay to keep your fund running, should be minimal because index funds are passively managed. Because all S&P 500 index funds perform identically, the amount you spend in fees becomes a critical consideration when choosing a fund.

(iii) Minimum Investment
The minimum investment is required. For taxable investment accounts and IRAs, index funds have differing investment minimums. Make sure your choices are compatible with the initial investment amount and that you’ll be able to buy more shares at regular intervals that fit your budget.

(iv) Yield on dividends
One of the advantages of investing in large-cap firms is the ability to receive dividends. Dividend yield should be compared between index funds because dividends can help enhance returns even in low markets.

(v) Starting Date
Pay attention to the fund’s inception date if you’re an investor who prefers to evaluate a fund’s track record before investing. Longer-term funds can show you how an index fund profited during bull markets and minimized losses during downturn markets.

How Is the S&P 500 Calculated?

A free-float market capitalization-weighted approach is used to calculate the S&P 500. A company’s market capitalization is derived by multiplying its stock price by the number of outstanding shares. The term “free-float” refers exclusively to publicly traded shares and excludes “restricted stocks,” such as those held by insiders.

Best Index Funds

Index funds from a range of companies monitor a variety of broadly diversified indices, and some of the lowest-cost funds operating on the public markets are included in the list below. One of the most critical aspects of your total return when it comes to index products like these is cost. Here are some of the best index funds:

1. Vanguard Total Stock Market ETF (VTI)
Vanguard also provides the Vanguard Total Stock Market ETF, which basically covers the full universe of publicly traded stocks in the United States. It is made up of small, medium, and large businesses from various industries. The fund has been around since 2001 when it first began trading. You know the prices will be modest because Vanguard is the sponsor. The cost-to-income ratio is 0.03 percent. That means that every $10,000 invested will cost you $3 per year.

2. iShares Core S&P 500 ETF (IVV)
The iShares Core S&P 500 ETF is a vehicle sponsored by BlackRock, one of the world’s largest investment firms. This iShares fund tracks the S&P 500 and is one of the largest ETFs. With a start date of 2000, this fund is another long-term player that has closely followed the index throughout time. The cost-to-income ratio is 0.03 percent. That means that every $10,000 invested will cost you $3 per year.

3. SPDR S&P 500 ETF Trust (SPY)
The SPDR S&P 500 ETF is the granddaddy of all exchange-traded funds, having been established in 1993. It was instrumental in launching the current surge of ETF investing. It’s one of the most popular ETFs, with hundreds of billions in assets. The fund is sponsored by State Street Global Advisors, another industry heavyweight, and it tracks the S&P 500 index. The cost-to-income ratio is 0.09 percent. That means that every $10,000 invested will cost you $9 each year.

4. Invesco QQQ Trust ETF (QQQ)
The Invesco QQQ Trust ETF is another index fund that tracks the performance of the Nasdaq-100 Index’s top non-financial companies. This exchange-traded fund (ETF) was founded in 1999 and is managed by Invesco, a global investment firm. According to Lipper, this fund is the best-performing large-cap fund in terms of total return over the 15 years through September 2021. 0.2 percent expense ratio, which means that every $10,000 invested will cost you $20 per year.

5. Fidelity ZERO Large Cap Index (FNILX)
The Fidelity ZERO Large Cap Index mutual fund is part of Fidelity’s effort towards no-expense-ratio mutual funds, hence the ZERO designation. The fund doesn’t track the S&P 500; instead, it tracks the Fidelity U.S. Large Cap Index, although the distinction is purely academic. The fundamental difference is that Fidelity doesn’t have to pay a licensing fee to use the S&P name, which keeps costs down for investors. The expense ratio is 0%. That means that every $10,000 invested will cost you nothing in the long run.

6. SPDR Dow Jones Industrial Average ETF Trust (DIA)
When it comes to ETFs that track the Dow Jones Industrial Average, there aren’t many options, but State Street Global Advisors comes through with this fund that tracks the 30-stock index of large-cap firms. The fund was one of the first ETFs, being launched in 1998 and managing tens of billions of dollars. The cost-to-income ratio is 0.16 percent. That means that every $10,000 invested will cost you $16 each year.

7. Schwab S&P 500 Index Fund (SWPPX)
The Schwab S&P 500 Index Fund, with tens of billions in assets, is on the lesser side of the giants on this list, but that’s not an issue for investors. This mutual fund has a long track record, dating back to 1997, and it’s sponsored by Charles Schwab, one of the industry’s most well-known names. The fund’s ultra-low expense ratio reflects Schwab’s commitment to providing products that are beneficial to investors. The cost-to-income ratio is 0.02 percent. That means that every $10,000 invested will cost you $2 each year.

8. Vanguard Russell 2000 ETF (VTWO)
The Russell 2000 Index is a collection of around 2,000 of the smallest publicly traded firms in the United States, and the Vanguard Russell 2000 ETF monitors it. This ETF began trading in 2010, and it’s a Vanguard fund, so it focuses on keeping costs low for investors. The cost-to-income ratio is 0.10 percent. That means every $10,000 invested would cost $10 annually.

9. Vanguard S&P 500 ETF (VOO)
The Vanguard S&P 500, as its name suggests, mimics the S&P 500 index and is one of the largest funds on the market, with hundreds of billions in assets. This exchange-traded fund (ETF) was launched in 2010 and is supported by Vanguard, one of the largest investment companies in the world. The cost-to-income ratio is 0.03 percent. That means that every $10,000 invested will cost you $3 per year.

10. Shelton NASDAQ-100 Index Direct (NASDX)
The Shelton Nasdaq-100 Index Direct ETF tracks the performance of the Nasdaq-100 Index’s largest non-financial businesses, which are mostly tech companies. This mutual fund has an excellent track record over the last five and 10 years, having started trading in 2000. 0.5 percent expense ratio. That means that every $10,000 invested will cost you $50 per year.

Points to Focus While Investing in Index Funds

(i) Long-Term Performance
It’s crucial to monitor the index fund’s long-term performance (preferably for at least five to ten years) to determine your prospective future returns. Each fund may track a different index or outperform another, and some indices perform better over time than others. Long-term performance is the best indicator of what to expect in the future, but it’s no guarantee.

(ii) Expense Ratio
The cost ratio illustrates how much you’re paying for the fund’s annual performance. It makes little sense to spend more than necessary for funds that track the same index, such as the S&P 500. Other index funds may follow indexes with superior long-term performance, allowing for a higher expense ratio.

(iii) Trading Costs
When it comes to buying mutual funds, some brokers provide even better deals than the mutual fund firm itself. If you want to trade an ETF, almost all major online brokers now allow you to do so without paying a commission. Also, be wary of sales loads, or commissions, which may easily shave off 1% or 2% of your money before it’s invested if you’re buying a mutual fund. These can be avoided by carefully selecting funds, such as those offered by Vanguard and others.

(iv) Fund Options
However, not all brokers will offer all mutual funds. As a result, you’ll need to check with your broker to determine if a specific fund family is available. ETFs, on the other hand, are often available through any broker because they are all traded on the same exchange.

(v) Convenience
Rather than opening a new brokerage account, it may be easier to go with a mutual fund that your broker offers on its platform. However, using an ETF rather than a mutual fund may allow you to avoid this problem.

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What makes an Expense Ratio Good?

Mutual funds and exchange-traded funds (ETFs) offer some of the lowest average expense ratios, albeit the figure varies depending on whether they invest in bonds or equities. On an asset-weighted basis, the average stock index mutual fund paid 0.06 percent in 2020, or $6 for every $10,000 invested. For every $10,000 invested, the typical stock index ETF charged 0.18 percent (asset-weighted), or $18.

Index funds are typically substantially less expensive than normal funds. Compare these figures to the average stock mutual fund (on an asset-weighted basis) charging 0.54 percent and the average stock ETF charging 0.18 percent. While the ETF expense ratio is the same in both cases, mutual fund costs are typically greater. Many mutual funds are not index funds, and thus charge greater fees to cover their investment management teams’ increased expenses.

In comparison to average funds, index funds are typically substantially less expensive. In comparison, the average stock mutual fund charged 0.54 percent on an asset-weighted basis, while the average stock ETF charged 0.18 percent. While the fee ratio for ETFs is the same in both cases, mutual fund costs are often greater. Many mutual funds are not index funds, hence they charge greater fees to cover their investment management teams’ increased expenses.

How do index funds work?

An index fund is a type of investment fund that is based on a predetermined basket of stocks or indexes. It can be a mutual fund or an exchange-traded fund (ETF). The fund management or another organization, such as an investment bank or a brokerage, may develop this index. These fund managers then imitate the index, establishing a fund that is as close to the index as possible without actively managing it. As companies are added and removed from the index, the fund manager mechanically duplicates those changes in the fund.

Index funds are regarded as a type of passive investing, rather than active investing, in which a fund manager evaluates equities and seeks to identify the best performers, because of this strategy.

Index funds tend to have low expense ratios as a result of their passive methodology, making them affordable for new investors. The S&P 500, Dow Jones Industrial Average, and Nasdaq-100 are some of the most well-known indices. Indexing is a common ETF approach, and the majority of ETFs are based on indexes.

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Is investing in the S&P 500 right for you?

Warren Buffett, the legendary stock market investor, famously stated that a low-cost S&P 500 index fund is the best investment most people can make. It’s easy to understand why. The S&P 500 has provided annualized total returns of 9% to 10% over lengthy periods of time, and you can easily participate in a passive S&P 500 fund for virtually no cost.

To be clear, we (and Warren Buffett) believe that if you have the time, knowledge, and drive to properly analyze stocks and manage a portfolio, you may earn greater long-term investment returns to the S&P 500. However, not everyone has the time or discipline to invest in stocks in this manner, and rookie investors, in particular, may be better served by purchasing shares in an S&P 500 index fund until they gain experience.

In a word, investing in the S&P 500 allows you to gain broad exposure to the profitability of American firms without being overly exposed to the performance of any specific company. With little work on your part, the S&P 500 can provide excellent returns for your portfolio over time.

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