What is the S&P 500 Index?

The Standard & Poor's 500 Index (abbreviated as S&P 500) is considered one of the oldest and most representative indices in the United States stock market.

The S&P 500 Index covers the 500 largest market capitalization companies listed on the US stock exchanges, accounting for approximately 80% of the total market capitalization of the US stock market. Since some companies have two types of stocks traded on the market, the S&P 500 Index actually includes 503 component stocks. For example, Alphabet has issued Class A shares (GOOGL) and Class C shares (GOOG).

Most of these companies have market capitalizations exceeding $14.5 billion, and as of August 31, 2023, the top ten component stocks of the S&P 500 Index accounted for 30.9% of the overall index market capitalization. Additionally, all component stocks of the S&P 500 Index are listed on either the New York Stock Exchange or the NASDAQ.

The calculation method of the S&P 500 Index is based on market capitalization-weighted average. The weight of each component stock is determined by the company's market capitalization. In other words, the larger the market capitalization of the company, the higher its weight in the S&P 500 Index, thus exerting a greater influence on the index.

Importance of the S&P 500 Index

In 1860, Henry Varnum Poor founded Poor's Publishing Company and published investment guides for the railway industry. Later, in 1926, the company introduced a composite price index consisting of 90 stocks.

Furthermore, the Standard Statistics Company was established in 1906 and introduced an index covering 233 listed companies in 1923, which became the prototype of the later S&P 500 Index.

By 1941, Poor's Publishing Company merged with the Standard Statistics Company, and Standard & Poor's was born. In 1957, they expanded the constituent stocks of the original index to 500 stocks, which is now known as the S&P 500 Index.

The component companies of the S&P 500 Index include 11 industry categories, including information technology, communication, basic materials, energy, finance, industrials, real estate, consumer staples, consumer discretionary, utilities, and healthcare.

In addition to tracking the performance of each industry, the S&P 500 Index can also track the performance of different companies within the same industry. Therefore, compared to trading individual company stocks, the S&P 500 Index offers greater diversification and serves as an important indicator of the health of the US stock market and the overall economy.

Criteria for Inclusion in the S&P 500 Index

The S&P 500 Index tracks the stock price performance of the 500 largest publicly listed companies in the United States. However, not all companies can be easily included in the S&P 500 Index and must meet the following criteria to be listed on the S&P 500 Index:

- Headquarters established in the United States
- Market capitalization of at least $13.1 billion
- IPO for at least six months, with public shareholding of at least 50% of the outstanding shares
- Positive combined earnings for the most recent four consecutive quarters
- Active stock trading, high liquidity, and reasonable trading prices

Companies included in the S&P 500 Index not only need to meet strict criteria but also need to undergo quarterly reviews by the selection committee to reassess factors such as market capitalization, liquidity, and industry classification. Companies included in the S&P 500 Index must cover various major industries, so companies selected for inclusion in the index are undoubtedly leading companies in the United States.

Differences Among the Three Major Indices

S&P 500

The overall trend of the S&P 500 Index is similar to that of the Dow Jones Industrial Average. However, its volatility has been greater than that of the Dow Jones Industrial Average since the end of 2022, as the Dow Jones Industrial Average has been relatively stable. The S&P 500 Index includes companies from different industries, and while its performance may not be as impressive as the NASDAQ Composite Index, overall, it still outperforms the Dow Jones Industrial Average.

Nasdaq

The Nasdaq Composite Index is similar to the S&P 500 Index, but the main difference lies in the larger proportion of technology stocks in the Nasdaq Composite Index, accounting for 55.32%. In addition, the Nasdaq Composite Index consists of over 3,000 component stocks, and it also uses market capitalization-weighted calculation method.

The component stocks of the Nasdaq Index not only cover US companies but also include companies listed on the Nasdaq Exchange in other countries.

Due to its focus on technology stocks, especially during the past five years, particularly during the outbreak of the pandemic, technology stocks have benefited the most and have been most affected by the pandemic recovery. The overall volatility of the Nasdaq Index is the most significant among the three indices. Compared to the S&P 500 and Dow Jones Industrial Average, the performance of the Nasdaq Index is superior. When the market rises, the Nasdaq's gains are greater, and when the market falls, its losses are also greater.

Dow Jones Industrial

The Dow Jones Industrial Average is a price-weighted index, meaning that stocks with higher prices have a greater impact on the index. The index covers the performance of 30 large publicly listed companies in the US stock market. Compared to the S&P 500 Index and the Nasdaq Composite Index, the Dow Jones Industrial Average tends to favor the financial sector.

The volatility of the Dow Jones Industrial Average is not as great as that of the S&P 500 Index and the Nasdaq Composite Index, making it the most stable of the three major indices. The Dow Jones Industrial Average is a price-weighted index with the smallest fluctuation range and the lowest growth rate among the three major indices.

Advantages of the S&P 500 Index

Diversified, diversified investment

The S&P 500 Index aggregates the 500 largest companies by market capitalization in the US stock market, covering leading US companies in various industries. This diversification reduces investment risk, ensuring that investors' returns are not affected by the negative impact of a single industry or company.

In the third quarter of 2023, the S&P 500 Index was heavily influenced by industries such as utilities, real estate, and consumer goods due to inflation and rising interest rates. With significant gains in the energy sector and growth in communication services, the S&P 500 Index rose by over 17.56% from the third quarter of 2022 to October 18, 2023.

Stable long-term returns

Most companies in the S&P 500 Index pay dividends, such as Apple, Microsoft, and NVIDIA. This allows investors to receive dividend income from these companies by investing in the S&P 500 Index. Although the S&P 500 Index may experience declines due to short-term economic downturns, from a long-term perspective, the performance of the S&P 500 Index is relatively stable.

High transparency

Companies included in the S&P 500 Index need to meet certain thresholds and undergo quarterly reviews by the selection committee to evaluate factors such as market capitalization, liquidity, and industry classification. The component stocks and weights of the S&P 500 Index are publicly disclosed every quarter, allowing investors to have a clear understanding of what they are investing in.

Easy to invest

Investors can easily invest in the S&P 500 Index by purchasing Exchange Traded Funds (ETFs) that track the S&P 500 Index, such as:

SPDR ETF (SPY)
iShares Core S&P 500 ETF (IVV)
Vanguard S&P 500 ETF (VOO)
SPDR Portfolio S&P 500 ETF (SPLG)

Among them, IVV, VOO, and SPLG are designed to cater to investors seeking the lowest management fees. SPY is favored by investors who prefer greater liquidity. Since these ETFs track the S&P 500 Index, their performance is usually very similar, and investors can choose based on the management fees and liquidity of each ETF.

Risks of the S&P 500 Index

Market risk

As a reflection of overall market performance, the S&P 500 Index is affected by market volatility and economic cycles. From 1969 to 1981, the US economy experienced stagflation, which caused the S&P 500 Index to continuously decline.

In addition, in 2009, the global financial crisis erupted, leading to economic downturns in various countries and severe damage to stock markets. During this period, the S&P 500 Index also experienced significant volatility, declining by as much as 57%.

Component stock limitations

The S&P 500 Index is often dominated by companies with large market capitalizations and only includes companies headquartered in the United States. Even a giant Chinese e-commerce company like Alibaba, with a market capitalization of $213.7 billion, cannot be found in the S&P 500 Index because its headquarters are in China.

For investors who prefer to select their investments, the S&P 500 Index may not be the best choice because they cannot choose which companies are included in the index fund. If you do not want to invest in certain companies' stocks, you have to accept them as part of the index fund.

Missing out on higher returns

Since the S&P 500 Index tracks the average performance of 500 companies, even if some companies achieve outstanding performance, they may be offset by the poor performance of other companies, meaning that investors may miss out on some potential high returns.

In the third quarter of 2023, the S&P 500 Index was dragged down by industries such as utilities, real estate, and consumer goods due to inflation and rising interest rates. Although the significant gains in the energy sector and growth in communication services had a positive impact, they were not enough to offset the losses in other industries.

Who Should Invest in the S&P 500?

Long-term investors

The S&P 500 Index covers the largest companies in the US by market capitalization, which have stable positions in the market and can maintain stable performance regardless of economic fluctuations. Therefore, long-term investors who choose to invest in the S&P 500 Index are essentially entrusting their funds to a group of market leaders, waiting for their returns to grow.

Beginner investors

By investing in the S&P 500 Index, beginner investors can easily gain exposure to stocks of 500 top US companies, achieving direct diversification of their investment portfolios without needing to spend too much time and effort researching each company.

Investors seeking stable growth

The companies in the S&P 500 Index are leaders in various industries, with stable financial conditions and market positions. During economic fluctuations, these companies usually maintain relatively stable performance, providing a safe and reliable investment haven for investors seeking stable growth.

Investors who spend little time

By investing in the S&P 500 Index, investors can easily invest in stocks of 500 companies without spending too much time and effort researching and managing each stock, saving time and effort while obtaining average market returns.

How to Invest in the S&P 500 Index?

A common way to invest in the S&P 500 Index is by purchasing Exchange Traded Funds (ETFs) that track the S&P 500 Index, such as:

SPDR ETF (SPY)
iShares Core S&P 500 ETF (IVV)
Vanguard S&P 500 ETF (VOO)
SPDR Portfolio S&P 500 ETF (SPLG)

Among them, IVV, VOO, and SPLG are designed to cater to investors seeking the lowest management fees. SPY is favored by investors who prefer greater liquidity. Since these ETFs track the S&P 500 Index, their performance is usually very similar, and investors can choose based on the management fees and liquidity of each ETF.