The S&P 500, a proxy for the US stock market, has historically outperformed many other financial investments. Investors who want to capture the market’s returns often consider the Standard & Poor’s 500 Index as the benchmark because it represents about 80% of the value of US equities.
The S&P 500 went on a tear in 2021—and those who invested in index mutual funds and exchange-traded funds (ETFs) that track its performance saw outsized returns.
The index posted a total return of 24% in the first three quarters of 2021. That topped the 18.8% return for the Dow Jones Industrial Average of 30 US blue-chip stocks. It also beat the 16.7% return for the Dow Jones Global Index, which aims to cover 95% of the market capitalization of stocks worldwide.
How to think about investing in the S&P 500
In the broadest sense, investing in the S&P 500 is tantamount to an investment in the stock market itself. In that respect, there is nothing complicated about it. For the most part, it is considered to be a low-cost, low-risk approach. However, that may not be what everyone wants: Those with an appetite for more risk may want to seek investments with the potential for faster growth, while those who want even less risk may seek other investment options with less exposure to the stock market, which can, after all, have significant ups and downs.
Potential advantages of investing in the S&P
There are a number of plusses to investing in the S&P:
- The S&P 500 reflects the performance of the US stock market, which historically has produced positive returns even when inflation is taken into account.
- The index historically has delivered average annual returns of about 10%.
- One share of a low-cost index fund captures the performance of 500 big companies.
- S&P 500 exchange-traded funds (ETFs) are easily traded on stock exchanges, meaning they can be quickly converted into cash.
- Most S&P 500 companies pay dividends as cash or for reinvestment in the fund.
- Index members may be added or removed quarterly to reflect their economic status, positioning the index to benefit from faster growing companies while leaving out laggards.
Potential drawbacks of investing in the S&P
There are also potential downsides to consider:
- Investors in S&P 500 index funds will match—but will never beat—the market.
- The index has suffered huge declines in some years.
- The S&P 500 weighting system gives a small number of companies major influence, which could have an undue negative effect on the index if one or a few of them run into trouble.
- The index does not expose investors to small or emerging companies with the potential for market-beating growth.
How to invest in the S&P
Investors who choose stocks often start with the S&P 500 Index—either in a mutual fund or an ETF. These index funds all track the same basket of large-cap companies and should deliver the same performance. The difference in returns to investors comes in the fees and costs associated with the funds. In index funds, these costs should vary little.
Many investors buy index funds that track the S&P through a brokerage account, either online or with a brokerage firm. There may be fees associated with making such an investment, although many brokerages, both virtual and real, have cut their fees to the bare minimum—and in some cases, they have eliminated them altogether.
Investors who want to compare the returns of the index funds above, or other securities of their choosing, can use an online fund-comparison tool. These will show minuscule differences in the returns—but differences nonetheless.
Funds that track the S&P 500
The SPDR S&P 500 ETF Trust, often known by its ticker symbol, SPY, is an ETF that holds shares of S&P 500 companies. It is the oldest and biggest ETF to track the index, with about $425 billion in assets under management. It was created in 1993 by State Street Global Advisors, which still manages the fund. It has an expense ratio of 0.09%, meaning that it costs an investor $9 a year for every $10,000 they’ve invested.
But it is just one of many funds that attempt to match the S&P’s performance. Some others are:
- Vanguard S&P 500 ETF (VOO). This ETF is offered by Vanguard, one of the biggest global investment management companies, with more than $7.5 trillion in assets under management. Its expense ratio is 0.03%.
- iShares Core S&P 500 ETF (IVV). This is among the largest S&P 500 ETFs. It’s sponsored by BlackRock, the world’s largest asset manager. The expense ratio is 0.03%.
- Schwab S&P 500 Index Fund (SWPPX). This fund is on the smaller side of the heavyweights noted here, with about $65 billion invested. Charles Schwab, which started as a discount broker, is now the third largest global assessment manager, with a range of services. The expense ratio is 0.02%.
- Fidelity ZERO Large Cap Index (FNILX). This mutual fund follows the Fidelity U.S. Large Cap Index, which is similar, though not identical, to the S&P 500. In particular, the weightings of the top holdings may vary slightly from the S&P. Fidelity is a major multinational financial services company. This fund has an expense ratio of zero, meaning investors do not pay this fee at all.
Average S&P 500 returns vs. other investments
Stocks have generally offered investors better returns than bonds over time, and 2021 has been no exception. From 1926 to 2020, stocks posted average annual gains of 10.3% before inflation and had losses in 25 years. Bonds’ average annualized return was 6.1% with losses in 19 years, a Vanguard study shows.
Bonds have performed much worse in the first three quarters of 2021. An index that tracks the total returns of 100 large, liquid investment-grade bonds of US companies, called the Dow Jones Equal Weight U.S. Issued Corporate Bond Index, returned a negative 1.18%.
US government Treasury bonds performed even worse. The S&P U.S. Treasury Bond Index had a total return of a negative 2.04%. Bonds have not always been such extreme laggards. But stocks have held the upper hand in the long run.
Does that mean the S&P 500 has consistently been a star performer? While the index has recorded average annual returns of about 10% over time, it has suffered some severe declines.
During the Great Depression, when the index tracked 90 rather than 500 companies, it dropped 24.9% in 1930. The next year, it tumbled 43.3%. But two years later, in 1933, the index soared 54%, the biggest surge in its history.
The index took another nosedive during 2008 amid the global financial crisis, plummeting 38.5% that year. But it started climbing back in 2009 and went on to set record highs in the longest bull market in history. During the next 10 years, the index gained more than 330%.
FAQs about investing in the S&P
Can an S&P 500 index fund investor lose all their money?
Anything is possible, of course, but it’s highly unlikely. For an S&P 500 investor to lose all of their money, every stock in the 500 company index would have to crash to zero. If this were to happen, the overall status of the planet, not of one’s investment portfolio, might be the greater concern.
What is considered a good expense ratio for an S&P 500 fund?
Index funds that track the S&P 500 are inexpensive, as well they should be: The human effort required to manage such a fund is very limited. For example, the Vanguard 500 Index Fund Admiral Shares, a mutual fund, has an expense ratio of 0.04%, meaning the fund charges $4 for every $10,000 in assets under management. But some funds charge much more, though they offer virtually the same performance.
Is the S&P 500 better than the Dow Jones?
“Better” may not be the best way to characterize the differences. The S&P 500 is made up of the shares of 500 of the largest US companies, representing a vast swath of the US economy. The Dow consists of just 30 stocks belonging to some of the biggest, though more established, companies. Perhaps because the S&P 500 contains more new, fast-growth companies, in the period starting in 2016 and ending Sept. 30, 2021, it outperformed the Dow, gaining 95% versus 76%. However, the Nasdaq Composite Index, with many hot tech companies, beat both, rising 171%.
The bottom line
The US stock market has historically rewarded investors with higher returns than most other financial investments. The S&P 500 is typically regarded as the benchmark for US equities and has produced average annual returns of about 10%, or a bit more than 7%, adjusted for inflation. The S&P 500 has, of course, suffered major annual declines—but in time it has recovered and risen to record highs.