The Standard & Poor’s 500 Index, commonly called the S&P 500, tracks 500 of the largest companies trading on major US stock exchanges. Investors view the index as a benchmark to gauge overall stock market performance because it represents about 80% of the total value of US equity markets. The S&P 500 index is also considered a barometer of economic health, as it reflects the fortunes of the top US companies and the industries they represent.
Today’s index started on a smaller scale in 1923. It expanded to cover 500 companies in 1957. It was the first market-cap weighted US stock index and the first one generated by a computer. Today it represents a total 505 common stocks issued by 500 large-cap companies, reflecting the fact that some companies such as Berkshire Hathaway Inc. have two classes of shares.
Financial institutions began establishing investment funds that tracked the S&P 500 in the 1970s. Today, an estimated $13.5 trillion is indexed or benchmarked to the index, according to S&P Global.
What companies are in the S&P 500?
Companies are invited to join the S&P 500 based on their market capitalizations and other criteria that indicate their financial stability. S&P Dow Jones Indices, a unit of analytics firm S&P Global Inc., determines which companies to add and subtract and makes other decisions affecting the index.
“The construct of the index is really changing,” explains Titan investment manager Christopher Seifel. “It mirrors economic activity. Now there's a much larger weighting of technology and the S&P than there was before. If you think about it on a very simplistic basis, those are the companies that are going to become more valuable.”
Companies with the biggest market caps receive the heaviest weighting in the index. They have more impact on the S&P 500’s performance than smaller members.
Companies don’t automatically remain in the S&P 500 forever. The index administrators review and update the component companies four times a year. Companies may be taken out of the index if they fail to meet market cap and other financial requirements.
“Whenever a company is added,” Seifel explains, “usually you'll see a certain company be taken out, almost on a one for one basis.”
Companies that change hands in a merger, go private, or move their domicile from the US also risk removal. For instance, printer company Xerox Corp. was removed in 2021 when its market cap fell below the minimum requirement. It was replaced by equipment maker Generac Holdings Inc.
How do market indexes work?
Indexes use differing methods to calculate value. The S&P 500 is known as a free-float market capitalization weighted index. It derives its value from the market caps of its component companies. (Market cap here is the number of a company’s publicly traded shares multiplied by their current share price. It does not include shares held privately.)
The market cap of the index itself is determined by adding together all of the company market caps. The weight of each company is then calculated by dividing its market cap by the total market cap of the index.
The Dow, in comparison, is a price-weighted index. Its value is calculated by adding the stock prices of the 30 component companies and dividing by a divisor. The divisor, which is calculated and updated by The Wall Street Journal, creates a more manageable index value as opposed to the random number resulting from adding all the share prices together.
For example, if the total of the stock prices in an index equaled 717, a divisor of 7.17 might be formed to make the trackable value of the index 100. The Dow divisor has changed dramatically over the index’s history to reflect stock splits, dividends, or when a company joins or leaves the index.
Investors follow both the S&P 500 and the Dow when assessing US stock market trends. The S&P 500 offers a broader look because it includes a larger sample of US stocks.
Investing in the S&P 500
No one can invest directly in the S&P 500 or any other stock index. Instead, investors choose index mutual funds or exchange-traded funds (ETFs) that track the S&P 500 companies. These funds are available through brokerages and mutual fund providers.
Index mutual funds and ETFs have some key differences. Investors usually buy and hold mutual funds for longer periods of time. Mutual funds trade once a day and may have minimum investment levels. ETFs trade like stocks. Their price constantly changes throughout the day and they’re bought and sold more frequently than mutual funds.
S&P 500 index funds and ETFs track the same thing—the S&P 500 index. Their performance should mirror the performance of the index itself. Any difference in return to investors can come in the fees and costs charged by the investment companies that market the funds.
Is the S&P 500 a good investment?
The index has been setting record highs with increasing frequency. It reached its first 1,000-point close in 1998, notching that milestone in 12,186 trading days. It climbed to 2,000 in 2014 in 4,168 trading days. It hit 3,000 in 2019 in 1,227 days and jumped to 4,000 just 434 trading days later, in April 2021, and the index has reached new records since.
The index has also suffered major declines. During the 2008 financial crisis and Great Recession, the S&P 500 tumbled by more than half from October 2007 to March 2009. It recovered all of its losses by March 2013.
The index plummeted again during the coronavirus pandemic in March 2020. But it went on to double from that low by the end of August 2021.
Despite the ups and downs, long-term investors have benefited from putting their money into the S&P 500. Warren Buffett has famously said that 99% of investors are better off putting their money in the S&P as opposed to trying to pick stocks themselves and actively manage their own portfolio.
A majority of companies in the S&P 500 pay cash dividends to investors. The value of the index, however, does not include gains from these dividends. Investors factor those payments into their total return calculations.
Other stock market indexes
The S&P 500, though widely monitored and quoted, is only one of dozens of indexes worldwide that investors study to gauge stock market performance.
Another often-cited index, the Dow Jones Industrial Average, or the Dow, was the second US stock index formed, after the Dow Jones Transportation Index. The Dow tracks 30 companies on US exchanges including blue-chip corporations such as Coca-Cola Co., Nike Inc., and McDonald’s Corp. Almost all Dow stocks are included in the S&P 500, where they generally make up 25% to 30% of its market value.
The Nasdaq Composite Index covers most of the 2,800 stocks listed on the Nasdaq Stock Exchange. It is heavily weighted toward technology companies. Big names such as Apple Inc. and Microsoft Corp. are part of the Nasdaq Composite as well as the S&P 500 and the Dow.
Investors looking for indexes outside the US have numerous choices. The Financial Times Stock Exchange 100 Index, known as the FTSE 100 or Footsie, tracks the 100 companies with the biggest market caps on the London Stock Exchange. The DAX Performance Index, or DAX, consists of 40 major German blue-chip companies on the Frankfurt Stock Exchange. The Nikkei Stock Average, or Nikkei, is the index for the Tokyo Stock Exchange.
Individuals interested in the global outlook for equities can follow the MSCI World Index. It represents large and mid-cap equity performance across 23 developed market countries.
List of S&P 500 companies by weight
As the list below shows, the biggest companies also represent the biggest industry sector in the S&P 500: information technology. This is followed by health care, consumer discretionary, financials, communications services, industrials, consumer staples, energy, real estate, materials, and utilities.
As of November 4, 2021, the companies in the S&P 500 listed by weight are as follows:
Table data source: slickcharts.com
The bottom line
The S&P 500 Index reflects the trends of the overall US stock market. Individuals and investment professionals look to the index to gauge the health of the American economy based on the fortunes of the biggest publicly traded US companies.
The index uses a free-float market capitalization weighting method. This gives the largest and most valuable companies the greatest influence in the performance of the index. The top 10 index companies currently contribute about 30% of S&P 500 index value.
Individuals can’t buy directly into the S&P 500 index itself. Brokerages and mutual fund companies have developed index mutual funds and ETFs that let investors capture the performance of the S&P 500 companies, whether the results are positive or negative.