How to invest in the S&P 500

The S&P 500 (Standard & Poor’s 500) is a market-capitalization-weighted index of the top 500 publicly-traded stocks in the US stock market. The S&P 500 is one of the leading benchmarks used to gauge the performance of the US stock market.

Other known stock indices are the Dow Jones Industrial Average (simply known as Dow) – a blue-chip index that consists of 30 stocks – and the Nasdaq Composite. Of all indices, the S&P 500 is considered the most diverse and best representation of the state of the US stock market as it includes large-cap stocks from a wide range of sectors. The S&P 500 represents about 80% of the US stock market value.

How Did the S&P 500 Start?

The Standard Statistics Company created the first stock market index in 1923, consisting of the stocks of 233 companies; the index was computed weekly. In 1941 the Standard Statistics Company became Standard & Poor’s. On March 4, 1957, the index expanded to include the stock of 500 companies; the S&P 500 Stock Composite Index was created.

Which Companies are Included in the S&P 500?

Some quantitative criteria that a company must meet before it can be listed on the S&P 500 include meeting a minimum market capitalization requirement, having at least 50% of its shares available for public trading, and having a BBB or higher investment-grade credit rating. Companies must have four consecutive quarters of positive earnings to be considered for a spot on the S&P 500.

The index committee at Standard and Poor’s also considers the industry and sector representation of the companies in the index when making inclusion decisions; this creates a very diversified portfolio.

Some top companies in the S&P 500 include Apple Inc., Microsoft Corporation, Amazon.com, Inc., Alphabet Inc., Facebook, Inc., Berkshire Hathaway Inc., Visa Inc., Proctor & Gamble Co, Johnson & Johnson, and Coca-Cola Co.

Only US-based companies with publicly traded equities are included in the S&P 500.

How to Invest in the S&P 500

There is more to investing in the S&P 500; it goes beyond the direct purchase and trade of stocks. There is no way to directly invest in the S&P 500 or any other index because they are simply a measure of the performance of their underlying stocks. However, index funds and exchange-traded funds (ETF) provide a way to invest in indexes. These funds (index funds and ETFs) mirror the performance of specific indexes; hence investing in them is like investing in an index.

Index Funds and ETFs

An Index fund (also known as an index tracker) is a type of mutual fund that tracks a benchmark index. An index fund mirrors the composition and performance of an index. Index funds are a passive form of investment; their stocks are not traded frequently, hence, index funds management fees are generally lower. Some index funds track all the securities (stocks and bonds) in an index; while others invest in only select securities of the index they track.

The Vanguard First Index Investment Trust was launched in 1976 by Jack Bogle, the founder of Vanguard. It was the first US index fund available to retail investors; the index fund tracked the S&P 500 index.

ETFs are similar to index funds as they both track indices, provide a simple way for investors to diversify their portfolios, and employ similar investment strategies.

Some key differences between index funds and ETFs are: ETFs are actively traded, while index funds are only traded once daily at the close of the market. ETFs, as the name implies, are traded on the stock market, while index funds are not traded on exchanges. Because ETFs are traded on exchanges, they tend to be more liquid than index funds.

There are sector-specific index funds and ETFs. For example, the Vanguard Information Technology ETF (VGT.IV) tracks the performance of an index that measures the investment return of stocks in the information technology sector. Stocks of tech companies like Microsoft, Apple, NVIDIA, and Visa are included in the VGT.IV ETF.

Vanguard REIT Index Fund tracks the MSCI US REIT Index, an index that tracks domestic equity real estate investment trusts. Vanguard Health Care Index Fund Admiral Shares (VHCIX) offers exposure to the healthcare sector of the US equity market.

An elaborate Securities.io article that further highlights the similarities and differences between index funds and ETFs can be found here.

S&P 500 Index Funds or ETFs

Index funds and ETFs can be purchased directly from a mutual fund company or an ETF broker.

Some well-known index funds and ETFs that track the S&P 500 include

• Fidelity 500 Index Fund (FXAIX): A low-cost index fund, issued by Fidelity with an expense ratio of 0.015%. In 2021, the total return of FXAIX was 28.69%.

• Schwab S&P 500 Index Fund (SWPPX): Is also a fairly low-cost index fund with an expense ratio of 0.02%. Its 2021 return was 28.66%. SWPPX is issued by Charles Schwab.

• Vanguard 500 Index Fund (VFAIX): The original index fund that tracks the S&P 500. VFAIX has over $700 billion in assets under management. Its 2021 yield was 28.66%

• SPDR S&P 500 ETF (SPY): One of the most liquid and easily tradable S&P 500 index-based ETFs issued by State Street. It has an expense ratio of 0.09%, hence, it’s not a very low-cost ETF. Its annual yield for 2022 was 28.52%.

Index funds and ETFs that track the same index do not have much difference in their percentage return. The expense ratio for index funds and ETFs is the overall annual cost paid to the fund manager by investors. Expense ratios greater than 1.5% are considered high and unfavorable.

ETF brokers such as Fidelity Investments, TD Ameritrade, and IBKR are some of the well-known online brokers that offer index-based ETFs.