One of the most straightforward ways to take the pulse of U.S. financial markets is the S&P 500, an index that tracks the performance of most of the biggest companies in the U.S. At a glance, the S&P 500 gives you a sense of the general health of the U.S. economy, the direction of the stock market, and which kinds of stocks are rising or falling.
Here’s what you need to know about the S&P 500, including what it is, its history, how it works, and how you can invest in it.
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What is the S&P 500 Index?
The S&P 500, short for the Standard & Poor’s 500 Index, is a stock-market index that consists of 500 of the largest publicly traded companies operating in the U.S. The S&P 500 includes companies across 11 broad industry groups, or sectors.
The order of S&P sectors is based on market value and includes:
- Communication services
- Consumer discretionary
- Consumer staples
- Health care
- Information technology
- Real estate
Standard & Poor’s, a major index provider, financial-data source, and credit-rating agency introduced the Composite Index, a predecessor to the S&P 500, in 1926. It had 90 stocks. In March 1957, the index was enlarged to 500 stocks and was renamed the S&P 500.
McGraw-Hill, a publishing house, acquired Standard & Poor’s Corp., owner of the S&P 500 index, in 1966. Today, the S&P 500 is maintained by S&P Dow Jones Indices—a joint venture owned by S&P Global (previously McGraw Hill Financial), CME Group, and News Corp. (the parent of Dow Jones).
How does the S&P 500 work?
The S&P 500 contains 505 common stocks (in some cases, companies have issued more than one class of shares) selected based on market capitalization, or the total value of a company’s shares outstanding. The index includes the 30 companies that make up the Dow Jones Industrial Average, and it accounts for 80% of the U.S. equity market by capitalization.
The S&P 500 does a simple calculation to establish the weighting of each company in the index, giving companies with larger market values higher percentage allocations. The formula gives the biggest company in the S&P 500, Apple Inc., with a market value of more than $2.4 trillion, an index weighting of about 5.6%, as of 2021. That means its share-price movements have a much bigger effect on the index than one of the smallest companies in the index, HollyFrontier Corp., with a market value of about $5 billion and a weighting of just 0.009%, as of 2021.
A company’s S&P 500 weighting is calculated by dividing its market cap by the market value of all the companies in the index.
Company market cap / Total S&P 500 market cap = Company weighting in S&P 500
As of June 30, 2021, the S&P 500 total market cap was about $36.32 trillion.
The market cap of a company is calculated by multiplying the number of a company’s shares outstanding by its current stock price. For example, a company with 10 million publicly traded shares and a stock price of $10 has a market cap, or value, of $100 million.
To be eligible for inclusion in the S&P 500, a company must:
- Be based in the U.S., with a significant share of its fixed assets and revenues in the U.S. However, some companies domiciled in overseas tax jurisdictions are considered American for listing purposes.
- Have an unadjusted market cap of at least $13.1 billion.
- Be highly liquid, meaning its shares can be easily traded.
- Make at least 50% of its stock available for public trading and be listed on a major exchange such as the New York Stock Exchange, or one of the Nasdaq or Cboe exchanges.
- File a 10-K annual report.
- Have positive total net income in the four most recent quarters.
As of June 30, 2021, Top 10 Constituents by Index Weight:
The data above comes from S&P Dow Jones Indices.
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S&P 500 historical returns
Since the late 19th century, the S&P 500 has delivered 10-year average annual returns of 9.2%, according to Goldman Sachs data. Between 2010 and 2020, however, the S&P 500 outperformed, with an annual average return of 13.6%.
How inflation affects the S&P 500
When adjusted for inflation, which tends to erode the value of financial assets, the S&P 500’s historical average annual return is about 7%. Some investors doubt that this inflation-adjusted figure is accurate because it’s based on figures from the Consumer Price Index, or CPI, which some analysts say tends to understate rising prices.
Although the effects of inflation vary from sector to sector, unexpected inflation can reduce returns by:
- Increasing input costs, such as materials and labor;
- Raising borrowing costs; and
- Reducing expectations for earnings growth.
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