What is the S&P 500 Index?
A Brief Introduction to the Standard and Poor's 500 Index and Its Components
Even if you are starting the process of investing, you've probably seen, or heard about, the S&P 500 so many times you undoubtedly have asked yourself, "What is the S&P 500?" along with "Why is the S&P 500 so important?" Those are both good questions and my hope is that, in the next few moments, I can answer them for you. I also want to touch on some of the S&P 500 components so you understand how they are selected.
The Definition of the S&P 500
The Standard and Poor's 500, or S&P 500 as it is often called, is a stock market index made up of five hundred different stocks. That basically means it's a list that is compiled based upon pre-selected rules. In this case, each of the five hundred businesses is selected for liquidity, size, and industry. The index is weighted for market capitalization so that a company that is,say $100 billion receives 10x the representation as one that is $10 billion (there are exceptions to this but they are known as the "equal-weight" or "equally-weighted" S&P 500, which is something few people talk about outside of academia or professional circles).
The S&P 500 is the benchmark of the overall market, and frequently used as the standard of comparison in terms of investment performance. These days, the S&P 500 is essentially like investing in America, Inc.
There is a common misconception among inexperienced investors that the S&P 500 is a passive index.
It's not; not truly, anyway. The S&P 500 is, for all intents and purposes, actively managed by a committee of individuals who change the rules by modifying the calculation used to determine portfolio weightings, kicking out different types of companies entirely, adding securities that were not originally part of the index, et cetera.
I provided an in-depth explanation of this in an article called Investing in Index Funds for Beginners: The Good, The Bad, and the Ugly of Investing in Index Funds and even discussed things like what I called the S&P 500's dirty little secret - the fact that the managers of the index have so fundamentally changed the rules in recent years that investors have no idea what they own looks nothing like their grandfather's S&P 500.
The Biggest Holdings in the S&P 500
As the stock prices of each of the businesses change, the total weightings fluctuate. To give you a general idea, as of September 2015, the portfolio weights of the largest components are:
- Apple = 3.71%
- Google (both classes) = 2.07%
- Microsoft = 2.01%
- ExxonMobil = 1.80%
- Johnson & Johnson = 1.49%
- General Electric = 1.43%
- Wells Fargo = 1.43%
- JPMorgan Chase = 1.36%
- Berkshire Hathaway = 1.30%
- AT&T = 1.17%
- Pfizer = 1.13%
- Amazon.com = 1.12%
- Procter & Gamble = 1.10%
- Facebook = 1.08%
- Verizon = 1.07%
- Bank of America = 0.98%
- Citigroup = 0.93%
- Walt Disney = 0.91%
- Gilead Sciences = 0.88%
- Coca-Cola 0.88%
- Chevron = 0.87%
- Merck = 0.87%
- Home Depot = 0.87%
- Visa = 0.79%
Is the S&P 500 Diversified?
The short answer: Yes. The more accurate answer: Not nearly as much as people think it is.
For example, those few businesses we just went over represent 31.25% of the S&P 500. Should they opt to attempt to mimic the S&P 500, a majority portion of an investor's money would be invested in the top handful of components.
How Can an Investor Actually Invest in the S&P 500?
If you want to mimic the S&P 500, there are a few ways to do it. If you are affluent or high net worth, constructing your own personal index fund can provide superior tax efficiency and, in some cases, lower costs. For example - and keep in mind this is a bit oversimplified - if you had $1,000,000 in investable assets, you would go down the line and buy $37,100 worth of Apple, $20,700 worth of Google, $20,100 worth Microsoft, until you had reached Diamond Offshore Drilling, which would receive a mere $87.38 of your capital.
More commonly, you would invest in a low-cost index fund that mimicked the S&P 500 methodology but it is unbelievably stupid to do this in a taxable account if you have a decent-sized portfolio for a variety of reasons including the aforementioned tax considerations.
When Was the S&P 500 Invented?
The original predecessor to the S&P 500 was launched in 1957, though it looked nothing like the S&P 500 of today. As we discussed a few moments ago, the folks who run the stock market index have slowly, yet substantially, changed it over time. In fact, there is considerable academic evidence if the changes put in place over the past 13 years had been in effect from the beginning, the S&P 500 would have compounded at much lower rates; a warning you won't see on any index funds at present.
For example, the highly profitable foreign firms that were responsible for fueling a lot of the index growth were dropped. Then, something called a float-adjustment was implemented that, while reasonable and perhaps done with good intentions, will all but assure that rich insiders are able to unload their overvalued stock on mom and pop index fund owners. Most recently, the people responsible for it foolishly decided to introduce mortgage REITs, which are firms that are not really operating businesses, and not even real estate, but more akin to baskets of fixed income securities.
What was the most successful original S&P 500 index component?
Philip Morris and its related companies hold the record for the all-time greatest S&P 500 component. Had you put $1,000 in the firm back when the S&P 500 started, and reinvested your dividends, including holding the numerous spin-offs you received, you'd now be sitting on over $10,000,000 and own everything from Mondelez International and the Kraft Heinz Company to Altria and Philip Morris International. It was a powerhouse that crushed everything else despite already being a household name. An enormous portion of these gains were driven by reinvested dividends.
The Balance does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.