The S&P 500 and How It Works
How the S&P 500 Tells You About America's Health
The S&P 500 is a stock market index that tracks the stocks of 500 large-cap U.S. companies. It represents the stock market's performance by reporting the risks and returns of the biggest companies. Investors use it as the benchmark of the overall market, to which all other investments are compared.
As of Aug. 31, 2020, the S&P 500 had an average 10-year annual return of 12.66%. S&P stands for Standard and Poor, the names of the two founding financial companies.
The S&P 500 was officially introduced on March 4, 1957, by Standard & Poor. McGraw-Hill acquired it in 1966. The S&P Dow Jones Indices owns it now and that's a joint venture between S&P Global (formerly) McGraw Hill Financial, CME Group, and News Corp, the owner of Dow Jones.
How the S&P 500 Works
The S&P 500 tracks the market capitalization of the companies in its index. Market cap is the total value of all shares of stock a company has issued. It's calculated by multiplying the number of shares issued by the stock price. A company that has a market cap of $100 billion receives 10 times the representation as a company whose market cap is $10 billion. As of July 2020, the total market cap of the S&P 500 was $27.05 trillion.
The index is weighted by a float-adjusted market cap. It only measures the shares available to the public. It does not count those held by control groups, other companies, or government agencies.
A committee selects each of the index's 500 corporations based on their liquidity, size, and industry. It rebalances the index quarterly, in March, June, September, and December.
To qualify for the index, a company must be in the United States, have an unadjusted market cap of at least $8.2 billion. At least 50% of the corporation's stock must be available to the public. Its stock price must be at least $1 per share. It must file a 10-K annual report. At least 50% of its fixed assets and revenues must be in the United States. Finally, it must have at least four consecutive quarters of positive earnings.
As of Aug. 31, 2020, the 10 largest companies, with a weighted market cap, in the S&P 500 were:
- Apple Inc.
- Microsoft Corp.
- Amazon.com Inc.
- Facebook Inc. A
- Alphabet Inc. A (GOOGL)
- Alphabet Inc. C (GOOG)
- Johnson & Johnson
- Berkshire Hathaway B
- Proctor & Gamble
- Visa Inc. A
The makeup of the S&P 500 industries reflects that of the economy.
As of Aug. 31, 2020, the S&P 500 sector breakdown included:
- Information Technology: 27.5%
- Health Care: 14.6%
- Consumer Discretionary: 11.2%
- Communication Services: 10.9%
- Financials: 9.9%
- Industrials: 7.9%
- Consumer Staples: 7.0%
- Utilities: 3.1%
- Real Estate: 2.8%
- Materials: 2.6%
- Energy: 2.5%
S&P 500 vs. Other Stock Market Indexes
The S&P 500 has more large-cap stocks than the Dow Jones Industrial Average. The Dow tracks the share price of 30 companies that best represent their industries. Its market capitalization accounts for almost one-quarter of the U.S. stock market. The Dow is the most quoted market indicator in the world.
The S&P 500 has fewer technology-related stocks than the Nasdaq. As of April 2020, 57% of Nasdaq allocations were in information technology compared to 23% for the S&P 500 at that time.
Despite these differences, all these stock indexes tend to move together. If you only focus on one, you will still be able to understand how well the stock market is generally doing. In other words, you don't have to follow all three.
Milestones of the S&P 500
The following table shows various milestone events of the S&P 500, including both highs and lows, and other memorable moments.
|Jan. 3, 1950||16.66||Record closing low, first close|
|June 4, 1968||100.38||First time above 100|
|Oct. 19, 1987||224.84||Black Monday|
|March 24, 1995||500.97||First close above 500|
|Feb. 2, 1998||1,001.27||First close above 1,000|
|Oct. 9, 2007||1,565.15||Highest close before financial crisis|
|Oct. 13, 2008||1,003.35||Largest % gain of 11.6%|
|March 28, 2013||1,569.19||New record high|
|Aug. 26, 2014||2,000.02||First close above 2,000|
|Sept. 21, 2018||2,929.67||New record high|
|Oct. 3, 2018||2,937.06||Highest intra-day|
|July 12, 2019||3,013.77||First close above 3,000|
|Feb. 19, 2019||3,393.52||New record high|
|March 12, 2020||2,480.64||Largest % decline since Black Monday, entered bear market|
|March 23, 2020||2,237.40||Stock crash low|
|August 18, 2020||3,389.78||New record high, end of bear market|
|August 24, 2020||3,431.28||Breaks 3,400|
|August 28, 2020||3,508.01||Closes above 3,500|
How to Use the S&P 500 to Make Money
Although you can't invest in the S&P, you can mimic its performance with an index fund. You could also buy shares of stocks that are in the S&P 500.
Be sure to weigh the stocks in your portfolio according to their market cap, as the S&P does.
You should use the S&P 500 as a leading economic indicator of how well the U.S. economy is doing. If investors are confident in the economy, they will buy stocks.
Since the S&P 500 only measures U.S. stocks, you should also monitor foreign markets. That includes emerging markets like China and India. It may also be a good idea to keep 10% of your investments in commodities, like gold. They tend to hold value longer when stock prices drop.
Besides following the S&P 500, you should also follow the bond market. Standard & Poor's also gives bonds credit ratings. When stock prices go up, bond prices go down. There are many different types of bonds. They include Treasury bonds, corporate bonds, and municipal bonds. Bonds provide some of the liquidity that keeps the U.S. economy lubricated. Their most important effect is on mortgage interest rates.
- Investors usually look at the S&P 500 to assess how the overall stock market is doing. As such, this index is considered a leading U.S. economic indicator.
- It tracks 500 publicly traded, large-cap U.S. companies. These businesses must meet specific criteria in order to be a part of the S&P 500. The mix of industries that make up the S&P 500 list often reflects the economic makeup of the United States.
- Investors can purchase shares of stocks listed on the S&P 500 or invest in index funds that track the S&P 500.
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