If you’re a would-be investor wondering how to grow your wealth without exposing yourself to too much risk, try investing in Wall Street’s biggest index.
Even as a complete newcomer to the trading world, you’ve likely heard about the S&P 500 index. The S&P 500 is one of the most important indicators of the US stock market’s overall health.
But what exactly is this index? And how to invest in an S&P 500 fund? Read on to find out and decide if it should become a part of your portfolio.
The S&P 500 Index, or the S&P for short, is a stock market index that tracks and measures the performance of 500 US companies. Along with the Dow Jones Industrial Average (Dow 30), the Russell 2000, and the Nasdaq 100, it’s one of the most famous stock market indices in the United States.
Standard & Poor’s, an American investment information service, created the S&P 500 in 1957. Since its introduction, the agency’s investment committee has been gathering every quarter to review the changes in the index, and thus the stock market, and determine which stocks should remain part of the index, which new ones should be brought on, and which no longer belong.
The committee looks at a company’s market capitalization, group representation, and liquidity, among other factors. Since some of the included companies have multiple shares classes, more than 500 stocks – 505 to be exact – comprise the S and P of today.
Contrary to what people may think, the stocks forming the index aren’t necessarily those of the 500 biggest US companies. One could argue, however, that they belong to the 500 most important ones.
The combined investment though the index exceeds $11.2 trillion, and these 505 stocks make for approximately 80% of the US stock market’s total value.
Considering that it reflects almost all the largest US stocks, it comes as no surprise that the S&P 500 index is often referred to as “the market” as a whole.
Standard and Poor’s index weights its components primarily by market capitalization – the total dollar market value of a publicly-traded company’s outstanding stock shares. Also called the market cap, this equals the total number of a company’s outstanding shares multiplied by the current share price.
To qualify, an enterprise must have a market cap of at least $8.2 billion. Because the S&P 500 is capitalization-weighted, the largest stocks greatly influence both the index’s daily movements and its long-term performance.
The ten biggest stocks account for 27% of the index’s market value, and as of December 31, 2020, these are the top companies in the S&P 500 by market capitalization:
An index is a measure of its underlying stocks’ performance, so you can’t directly invest in the S&P 500 itself.
You can, however, buy shares from each of the 500 individual companies, as long as you don’t mind examining the financial fundamentals of 500 separate enterprises and making a total of 505 transactions.
Thankfully, taking on such an arduous task isn’t your only option as there are mutual funds and exchange-traded funds (also called ETFs) that can do all the work for you.
These instruments employ a passive index replication strategy and help investors get exposure to all the S&P stocks without the laborious analysis.
Thanks to Vanguard’s creation of the first US mutual fund to mimic the S&P 500, direct investing has been accessible and affordable to individual investors as of 1976. The launch of the first ETF that tracked the S&P 500 in a similar way came approximately two decades later.
Nowadays, almost all major fund companies and brokerages offer some kind of an S&P 500 investment opportunity.
In other words, you can buy S&P 500 index stocks as either mutual index funds or exchange-traded funds. Although these options share many similarities, there are also some key differences.
An index fund is a mutual fund that follows a passive investment strategy and seeks to match the market’s risk and return. Index funds trade only once a day, after the market closes, and are usually meant to be owned for a relatively long period.
Some have minimum investment lengths and minimum investment amounts, but index funds are known for charging much lower fees than actively managed funds.
S&P 500 ETFs are traded on an exchange, just like stocks: Their price repeatedly changes throughout the day as traders buy and sell. There are no minimum purchase amounts (apart from the price of a single share) or investment-time constraints.
Similar to index funds, ETFs offer fewer broker commissions and lower expense ratios than those you’d have to face if you were to buy individual stocks.
No matter which approach you decide on, there are several different ways to access these funds. You can embark on your S&P 500 investing journey with a bank, a full-service broker, a discount broker, or a robo-advisor. Let’s take a closer look at the advantages and disadvantages of each:
Many new investors consider banks the most convenient ways to approach investing in the S&P 500 simply because they let you keep all of your accounts – such as checking, savings, and investment accounts – in one place.
On the downside, these financial institutions tend to charge the highest fees, so it might turn out that investing in the S&P 500 through a bank is your most expensive option.
The most significant advantage of online trading platforms is that they charge low fees, which is also why they’re called discount brokerages.
However, low prices mean sparse benefits, as these platforms offer no advice on how to navigate your investing approach. If you lack experience, we suggest you ask around first and get at least some level of stock market understanding before starting your trading journey.
However, experienced investors who don’t need help figuring out how an S&P 500 index fund investment fits into their strategy would probably prefer a DIY approach.
You can also hire a financial advisor or a full-service broker to help you with this type of investment.
Keep in mind that this kind of service typically costs big bucks – working with a personal advisor is a luxury usually reserved for investors with a high net worth who don’t mind paying for a premium service.
On the plus side, a full-service advisor helps you understand your complete financial situation, provides a well-informed view on how investing in S&P 500 index funds and ETFs works, and guides you towards achieving a specific financial goal.
Considering that they combine the benefits of online platform low fees and the opportunity to discuss your investment approach with a financial advisor, it’s no wonder that robo-advisors are in high demand.
Also called automated investment advisors, these platforms are less hands-on than human brokers, as they employ an AI-powered approach to helping their users design and execute investment strategies.
These platforms sometimes also offer access to human financial planners who can help you make an S&P investment for a premium fee.
After you’ve made your choice to invest in an S&P index fund or an ETF and picked the best way to access these funds, it’s time to open an investment account.
Once again, there are several options: The most popular solutions include standard brokerage accounts (also called non-retirement or taxable brokerage accounts) and retirement accounts such as traditional IRAs, Roth IRAs, and 401(k)s.
Once you’ve opened a suitable investment account, it’s time to narrow down which S&P 500 index fund to buy into. To make sure that you go for the most affordable option, remember to look at the different funds’ expense ratios (the percentage of your assets you’ll have to pay in fees on an annual basis).
Comparing fees is crucial, as the returns on these funds should be more-or-less the same, considering that they all track the same index. Put simply, the lower the expense ratio, the more of that return you’ll get to keep.
There are quite a few reasons why investing in the S&P is often a very smart decision. No matter if you are just starting your investment journey or have been trading for some time and want to increase your exposure to the United State’s stock market, there are several advantages to look forward to:
Affordability. Index funds and ETFs are passively managed, which typically makes them inexpensive to invest in. Considering that you won’t lose much on fees, your S&P 500 returns will be higher.
Diversification. You probably already know how important it is to diversify your investments between multiple securities. When you invest in an index such as the S&P 500, your portfolio gets inherently diversified among different stocks. Thanks to this risk-prevention strategy, should some of the companies in the index perform poorly, your entire portfolio will remain in good standing.
Solid performance. The S&P 500 components are well-established companies that operate in various industries. As such, their stocks generally carry less risk and lower volatility. Investing in an index fund or an ETF that mimics S&P 500 stocks means that your returns will match the performance of the fund, which has had an average stock market return of 10% annually over the last few decades.
Simplicity. S&P index funds offer share ownership opportunities for hundreds of stocks, even if you buy just a single share of the fund. Given that it requires very little investment experience and almost no time at all, this approach is much simpler compared to buying individual stocks.
Each investment approach has its flaws. Although the upsides substantially outweigh the downsides, there are a few negative aspects of the S&P funds to consider:
Volatility potential. One of the most significant disadvantages of the S&P 500, from an investor’s point of view, is that the index assigns higher weights to companies with more market capitalization. In other words, the stock prices for Apple, Microsoft, and Amazon have a much greater influence on the index as a whole than S&P companies with a lower market cap.
Large-cap stocks only. If you want to do portfolio diversification right, you need to buy shares of small- and mid-cap companies along with large-caps, include cash and bonds along with stocks, and make sure to allocate funds to international companies, not just the domestic ones.
No, you cannot invest in the S&P 500 directly. However, there are other possibilities to explore: You can either buy a share of stock of each of the S&P 500 companies – which we would advise against doing – or you can invest in a mutual fund or an ETF that mirrors the S&P 500. The latter is a sound strategy, even among investors who don’t have millions to allocate to trading.
The answer to this question depends on the approach you choose and the platform you use. To get started, you’ll need roughly $250-$300 for an ETF and $2,000-$3,000 for an index fund.
If you don’t know how to buy into an S&P 500 ETF or an index fund, we suggest you work with an advisor to find the right investment opportunity and determine how much you can comfortably afford to buy.
Even if you hire a discount broker, a bank, or a robo-advisor, figuring out what you need to do won’t take long. The steps include deciding whether you want to buy an ETF or an index fund, opening a brokerage account, choosing a fund, and making a purchase.
If you are unsure about how to invest in the S&P 500 without running an unnecessary risk, we suggest you invest in index funds. The financial world is full of uncertainties, but the chances that any index fund mirroring the S&P will lose all of its value are practically nonexistent.