The S&P 500 is a highly regarded stock market index in the United States. Commonly called simply the S&P, the index tracks 500 large publicly traded companies, all of which are listed on either the New York Stock Exchange or the Nasdaq Stock Market.
The S&P 500 requires companies to have a market cap of at least $5.3 billion to be listed. Over time, some companies shrink, leading to some listed assets having market caps of around $2 billion on the low end. On the high end are some of the largest companies in the world, worth hundreds of billions of dollars, much like the massive companies listed on the Dow Jones Industrial Average (DJIA).
Nonetheless, because the S&P 500 takes into account data from 500 publicly traded companies, it’s considered by most to be a better representation of the health of United States markets than the DJIA.
History of the S&P 500
The history of the S&P 500 starts with a company called Standard Statistics Company, founded in 1923, which created its first stock market index in 1923. This index was computed weekly and included 233 stocks.
The success of this original index ultimately led to the development of a second index by Standard Statistics Company. Created in 1926, this new index consisted of 90 stocks with the composite price index computed daily.
In 1941, Standard Statistics Company merged with Poor’s Publishing. This partnership, now known as Standard & Poor’s, introduced the S&P 500 in 1957. It’s just one of many indices that have been launched by Standard & Poor’s over the years. The S&P 500 was created to track the health of the United States economy and is credited with successfully doing so for decades since its inception.
In the beginning, the S&P 500 did overwhelmingly well. In the index’s first 10 years, it grew to nearly 700 points (dollars). In other words, one share of each stock on the S&P 500 would have a value of about $700. With a starting level of 386.36 points, that’s a growth of more than 81%.
On the heels of the strong economic growth that took place following World War II, the S&P 500 climbed to an all time high of just over 750 points. But shortly following the milestone, the S&P 500 followed the U.S. economy through the downward spiral driven by high inflation and relatively flat economic growth that plagued the United States economy. These economic struggles would last from late 1969 to early 1983, dragging the index down throughout that period.
As the index was making a recovery from the economic decline, a strange event took place. On October 19, 1987 the U.S. stock market as a whole took a dive. There were no economic or geopolitical events that led to the decline. In fact, according to Time, it’s impossible to pin down the exact cause of the 1987 market crash that came to be known as Black Monday. To date, Black Monday marks the worst single-day decline — 20.4% in a single trading session — in S&P 500 history.
Fortunately, the crash that started with Black Monday wouldn’t last long. The market found support in December 1987, and from there, the index started a dramatic run that would lead to new record highs (above 2,250) by March of 2000, just before the burst of the dot-com bubble, which sent the S&P 500 into dramatic decline yet again.
As the index worked to recover, the 2008 economic depression started to weigh in, sending the S&P 500 further down as subprime mortgages led to a figurative collapse of the global economy.
Since the 2008 economic crisis, the S&P 500 continued to enjoy robust gains until recently. The index climbed to levels of around 3,380 by February of 2020 before taking a dive as the COVID-19 pandemic took hold around the globe, drastically increasing unemployment rates and causing economic strain.
Historically, the S&P 500 has outpaced the Dow Jones Industrial Average, but not by much. Since inception, the average annualized return on the Dow Jones Industrial Average works out to about 7.8%, while the S&P 500 has generated an annualized return of about 8.8%.
Stocks in the S&P 500
The 500 stocks listed on the S&P 500 are categorized into 11 different sectors:
- Information Technology. The combined market capitalization of all information technology stocks listed on the S&P 500 is approximately $9.30 trillion. Some of the most recognized names in this sector are Adobe, Apple, and Intuit.
- Health Care. The combined market capitalization of all health care stocks listed on the index is approximately $6.12 trillion. AbbVie, Cigna, and Humana are some of the hottest stocks in this sector.
- Consumer Discretionary. The combined market capitalization of all consumer discretionary stocks listed on the index is approximately $5.37 trillion. Companies of note in this sector include Advance Auto Parts, Amazon, and Best Buy.
- Financial. The combined market capitalization of all financial stocks listed on the S&P 500 is approximately $5.08 trillion. In this sector, you’ll find Allstate, Bank of America, and E*Trade.
- Communications Services. The combined market capitalization of all communications services stocks listed on the S&P 500 is approximately $4.64 trillion. Alphabet, CenturyLink, and Comcast are some of the biggest names listed in this sector.
- Industrial. The combined market capitalization of all industrial stocks listed on the index is approximately $3.46 trillion. Some of the most recognizable names in the sector include Caterpillar, Delta Air Lines, and FedEx.
- Consumer Staples. The combined market capitalization of all consumer staples stocks listed on the index is approximately $3.26 trillion. Household names like Campbell Soup, General Mills, and Hershey fall into this category.
- Energy. The combined market capitalization of all energy stocks listed on the S&P 500 is approximately $2.01 trillion. Some of the most recognizable energy companies listed on the index include Chevron, Exxon Mobil, and Hess.
- Materials. The combined market capitalization of all materials stocks listed on the S&P 500 is approximately $1.68 trillion. Packaging Corporation of America, Sherwin-Williams, and WestRock are some notable names in this sector.
- Utilities. The combined market capitalization of all utilities stocks listed on the index is approximately $1.30 trillion. You’ll find names like Duke Energy, NextEra Energy, and Southern Company in this sector.
- Real Estate. The combined market capitalization of all real estate stocks listed on the index is approximately $1.11 trillion. In this sector you’ll find names like Public Storage, Regency Centers, and SBA Communications.
These stocks are listed based on their weight in the index by market cap. Keep in mind that market capitalization changes every time the price of a stock moves.
Stocks listed on the S&P 500 are chosen by a committee that considers the following factors:
- Market Capitalization. Market capitalization refers to the total value of all outstanding shares of the company combined or, simply, the total value of the company as a whole.
- Liquidity. Liquidity has to do with the amount of shares that are traded in a predetermined period of time. For example, investors tend to follow average daily volume. Stocks with high average daily volume have high liquidity. As such, investing in these stocks means it will be easy to sell them in the future. However, investing in stocks with low liquidity could lead to an inability to sell shares when you want to.
- Domicile. Domicile is the location of a company’s main office. To be listed on the S&P 500, companies must be headquartered in the United States.
- Public Float. The public float is the amount of shares that have been issued to the public and are available to trade.
- Sector Classification. The company’s sector classification relates to the industry in which the company works. For example, Apple’s sector classification is technology.
- Financial Viability. Financial viability has to do with the financial strength of a company. The S&P 500 would take into account the amount of money the company has in the bank, their cash burn rate, revenue, and several other factors to ensure the company has the financial capability to stay afloat.
- Length of Time It has Been Publicly Traded. Finally, the S&P 500 considers how long the company has been a publicly traded company on the OTC (the over-the-counter market) before consideration. The longer and more successfully the company has been publicly traded, the better their chances of S&P 500 inclusion.
The three most important rules for S&P 500 consideration include a market capitalization over $8.2 billion, annual dollar value to float-adjusted market capitalization of at least 1.0, and minimum monthly trading volume of 250,000 shares for six consecutive months before the evaluation.
The S&P 500 undergoes various adjustments to reflect corporate actions that affect market capitalization. The goal of these adjustments is to keep the index as a whole consistent over time. Actions that often lead to adjustments include the issuance of new shares, spinoffs, mergers, and dividends.
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How to Use the S&P 500
There are several ways to use the S&P 500. Some of the most common applications include:
- As a Benchmark. The S&P 500 is widely considered to be the benchmark index of the U.S. stock market. That means you can use the index to compare returns from investments in your portfolio to overall market conditions. If your portfolio is beating the S&P in terms of returns, then you know you’re doing well. If the S&P is outperforming your portfolio, then it may be time to restructure in order to catch up.
- As an Investment. Due to the strong long-term growth seen throughout the S&P’s history, shares of the index are highly regarded among passive investors. Also, by purchasing shares of the S&P 500, investors have the ability to gain exposure to every stock in the index without paying transaction fees for each stock purchased, making this a relatively low-cost investment strategy.
- As a Performance Indicator. Technical investors often look for correlations between movement in specific stocks and other investment vehicles and indexes like the S&P 500. They measure this using a metric called the beta coefficient. If a stock is known to move in the same direction as the S&P 500 and at the same rate, it will have a beta of 1. If a stock has a beta of 0.5, it will generally realize about half of the movements seen from the S&P 500 as a whole.
- For Economic and Market Monitoring. Because the S&P 500 is such a large index and includes data from 500 of the largest publicly traded companies in the U.S., it can be a useful gauge of broad market conditions and the economy in general. After all, if the largest companies in the U.S. are doing well, it’s a positive sign for the economy as a whole.
- As a Measure of Historical Performance. Although not quite as old as the Dow Jones Industrial Average, the S&P 500 has been around for more than six decades. With so much history behind it, investors can use it to study correlations over time and exploit these correlations to generate returns in the market.
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Criticism of the S&P 500
The S&P 500 is one of the largest and most trusted indexes in the world. However, it’s not without its critics. Some of the most compelling arguments by critics include:
- No Gauge for Asset Diversification. The S&P 500, like all stock indexes, only tracks stocks. Most heavily diversified investors use various asset classes like bonds, mutual funds, and ETFs. Some argue that because the S&P 500 includes no data from asset classes outside of stocks, it isn’t an accurate gauge of what your portfolio should be doing.
- Large-Cap Focus. The S&P 500 only lists companies with multi-billion-dollar valuations. With such a focus on large-cap stocks — and not including any data from microcap, penny, small-cap, or mid-cap stocks — there is a strong argument that the index’s coverage fails to provide an accurate view of the market as a whole.
- Disproportionate Weighting. Some argue the S&P 500 is disproportionately weighted to the largest of the large companies listed. In fact, the top 50 of the 500 companies on the index control well over 50% of the entire index’s market capitalization. So movements in these few largest companies have a larger bearing on the performance of the index as a whole.
- Overly Large Size. While most use the S&P 500 specifically because of its size, many argue that the 500 companies listed on the index are far more than the average investor needs for diversification. This leads some financial experts to advise against purchasing shares of the index.
- Sector Allocation. The S&P 500 does not cap sector allocations, nor does it adjust for them. This means that over time, there is often a shift in the percentage of value of the S&P 500 as a whole across various sectors. One day, technology may be the strongest sector in the index. A year later, health care may take over. Some argue that this leads to overexposure to some sectors and not enough exposure to others while making allocation-related decisions in a portfolio as a whole difficult.
Regardless of the criticism the S&P 500 has received, the index has become one of the most widely recognized for several good reasons. With such a large list of assets, it has proven throughout history that it’s a strong gauge of both market and economic conditions.
Moreover, the S&P 500 makes passive investing a simple process, making it an attractive investment option for beginners. Because the S&P 500 is considered to be the leading benchmark for the U.S. market, many investors compare their returns to it. Others simply buy shares in the index and hold them for the long run.
As always, it’s important to remember the risks when investing. The S&P 500 tends to do best when economic conditions are positive, and it experiences losses during negative economic times. As such, buying and selling at the wrong time can yield substantial losses, as with any investment. So if you’re going to invest in the S&P 500 or any of its derivatives, do your research and invest with caution.