My Love/Hate Relationship With The S&P 500
The S&P 500 is an overrated investment option and you may be missing out if it is your only investment... but I do own it and think it has value. Here are the top 5 things you need to know...
The S&P 500 is comprised of...well you probably know... 500 companies (the largest publicly traded on the NASDAQ and NYSE).
You can't buy it directly, but fund companies create mutual funds or exchange traded funds that imitate it/track it - and usually pretty inexpensively.
Going back to 1926, it has positive returns 87% of the time in any rolling 5 year period and 95% of the time in any rolling 10 year period (rolling means sequential periods, e.g. 1926-1930, 1927-1931, 1928-1932, etc, etc). Pretty good odds! (Past performance is not indicative of future results... you're welcome compliance.)
It's limited to only US based companies and it only represents roughly 2.5% of the available public stocks in the world. While you get some big companies, you miss out on smaller US companies as well as international.
Eight companies make up almost 28% of the index based on their size. That's a lot of the pie in only a few companies...
There is a lot more to the investing world than just the S&P 500 and I'm glad we have the ability to invest in it and other parts of our world.
It's often the only index option in a 401(k) plan, where I would and do take advantage of it today (there should be more options though). I’d also take it over someone trying to time and/or beat the market!
If you want to to get a bit further in the weeds, keep reading below!
The Construction of the S&P 500 Index
The S&P 500, also known as the Standard & Poor's 500 Index, is one of the most widely utilized benchmarks for the U.S. stock market. It represents the performance of 500 large-cap stocks and provides investors with insights into the overall health and trends of the market. Understanding how the S&P 500 is constructed is crucial for investors.
Selection Criteria
Determining which stocks are included in the S&P 500 is a meticulous process conducted by the Index Committee at S&P Dow Jones Indices. The committee follows a set of well-defined criteria to ensure a representative and diversified sample of the U.S. equity market.
To be included in the S&P 500, a company must meet the following eligibility criteria:
”A company must be in the United States and have an unadjusted market cap of at least $13.1 billion to qualify for the index. 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”. (Source: The Balance)
Weighting Methodology
Once the eligible stocks are identified, they must be assigned appropriate weights within the index to accurately reflect their market influence. The S&P 500 uses a market cap-weighted methodology to determine the weight of each stock.
Market capitalization is calculated by multiplying the stock's price by the number of shares outstanding. Consequently, stocks with a higher market capitalization will carry more weight in the index (Apple, Microsoft, Amazon, Google, etc.). This approach means that larger companies have a more significant impact on the overall performance of the S&P 500.
At the end of the day, the S&P 500 can be a decent investment option, but I don’t typically want it to be my only investment option. There is literally a whole world of investing at our fingertips and my goal is to get my clients greater exposure across it.
