What is S&P 500? It’s importance & how does it work?

While talking about the performance of a market or an economy as a whole; Indices are a great reference point.  The Standard & Poor’s 500 or commonly referred as S&P 500 is one of the most followed indices to track performance of U.S. stocks.

What Is the S&P 500?

S&P 500 is the Standard & Poor’s 500 Composite Stock Price Index; it tracks 500 of the largest listed companies in the USA. 500 of America’s largest companies by market cap are tracked by the S&P 500. These are companies with total outstanding shares of more than $10 Billion. 500 of the largest companies in the USA means this index alone is enough to provide a complete overview of the market for analysts and investors alike.

Think of S&P 500 as the American Nifty.

S&P 500 companies

500 of the largest companies by market cap make up the S&P500 index. These companies are called as ‘constituents” and represent all major sectors / industry. Since S&P 500 is like a barometer of market value of the ‘constituents’, their weightage in the index is based on the market value of outstanding shares.

Companies with a larger market cap will have higher percentage share in the index and smaller market caps will have lower share in S&P 500 index.

Below are the Top 10 companies and their weightage in the S&P 500. Data as of 22^nd April, 2021

Note:  The company count actually goes on to 505 as there are companies which appear more than once like Alphabet. Some of the mighty 500 have more than one class of shares Class A, Class B etc.

S&P vs other American Indices

S&P 500 vs. Dow Jones Industrial Average

Dow Jones Industrial Average (DJIA) or simply referred to as ‘Dow’ tracks just 30 largest companies in the US and sector leaders in their own right. Functioning of Dow is very much different than the S&P 500 as Dow is price weighted.  This means that the company’s ranking or stature in the Dow index is equivalent to its share price. The S&P 500 goes by the company’s market cap to give it more weightage.

S&P 500 vs. NASDAQ 100

Nasdaq 100 tracks 100 of the largest and most actively traded stocks on the Nasdaq Stock exchange.

While Nasdaq uses a market-cap like S&P 500 to select the company, there are certain eligibility criteria that make it different than the S&P 500, these are,

• Must be trading on Nasdaq for atleast 2 years
• Daily minimum trading volume of 100,000 shares
• It can have international companies too

Nasdaq is heavily skewed toward towards the technology sector, so it cannot give the overall picture of the U.S. stock market. The S&P 500, however, can provide a very accurate picture of American economy.

How to Invest in the S&P 500

The Top 500 performing companies in the US should lure any investor. It is great for average investors to simply invest in S&P 500 index funds to get higher than average returns not to mention the abundant diversification.

Through your ‘Online Brokerage Account’ one can invest in shares of S&P 500 mutual funds or ETFs that essentially replicate the performance of S&P 500. The best part is the investments are passive which means no active monitoring required. These are also the least expensive choices for the investor with a slice of the American market.