If you’ve ever dipped so much as a toe into investing, you’ve probably heard about the Standard & Poor’s 500 Index.
The S&P 500 is the most common index used to track the performance of the U.S. stock market. It is based on the stock prices of 500 of the largest companies that trade on the New York Stock Exchange or the NASDAQ.
The S&P 500 is often hailed as a representation of the entire U.S. stock market and American business as a whole, but that is not entirely accurate. While it does give you exposure to a broad swath of the economy, it is heavily weighted toward specific market capitalizations, sectors, and industries, which is important to know if you are seeking to build a diversified equity portfolio.
S&P 500 Market Capitalizations
By design, the S&P 500 includes only large companies. Only the biggest companies with massive market capitalizations ($9.8 billion or more) are included—think of large firms such as Apple, Microsoft, Amazon.com, Facebook, and Alphabet, the parent company of Google. One could argue that the S&P 500 is 100% weighted toward large-cap firms, though many of the biggest firms would technically be considered mega-cap.
It's important for investors to know that while investing in the S&P 500 can give great returns, they may be missing out on returns from medium-sized and small companies. Those who are looking for exposure to smaller firms should consider investments that track the S&P 400, consisting of the top mid-cap companies, or the Russell 2000, which features mostly smaller companies.
Those who are looking for exposure to smaller firms should consider investments that track the S&P 400, consisting of the top mid-cap companies, or the Russell 2000, which features mostly smaller companies.
S&P 500 Sector and Industry Weighting
Any attempt to diversify your stock portfolio should include some attempt at diversification according to sector and industry. In fact, some investment strategies suggest a perfect balance of sectors, because any sector can be the best-performing group in any given year.
In recent years, certain sectors and industries have performed better than others, and that is now reflected in the makeup of the S&P 500. It also means that many sectors won't be as represented in the index.
As of December 22, 2020, the breakdown of sectors in the S&P 500 was as follows, according to State Street Advisors (the creator of the SPDR S&P 500 ETF Trust, an exchange-traded fund that seeks to track the performance of the S&P 500):
- Information technology: 27.60%
- Health care: 13.44%
- Consumer discretionary: 12.70%
- Communication services: 10.79%
- Financials: 10.34%
- Industrials: 8.47%
- Consumer staples: 6.55%
- Utilities: 2.73%
- Materials: 2.64%
- Real estate: 2.41%
- Energy: 2.33%
As you can see, the S&P is heavily weighted toward tech, health care, and consumer discretionary stocks. Meanwhile, there aren't as many utilities, real estate companies, or firms involved in producing and selling raw materials.
This weighting has changed greatly over the years. Look back 25 years, and you’ll likely see far fewer tech companies and more emphasis on consumer discretionary and communications companies. Go back 50 years, and the mix will look even more different.
Why It Matters
The weighting of the S&P 500 should be important to you, because the index is not always a representation of the types of companies performing the best in any given year. For example, while consumer discretionary may have been the top-performing sector in 2015, it ranked third in 2017 and seventh in 2019. The communications services sector was last in performance in 2017 but had ranked second just one year earlier. The financials sector was dead last in 2007 and 2008, in the midst of the financial crisis, but it claimed the top spot in 2012 and performed third-best in 2019.
Predicting which sectors will perform best in any given year is very difficult, which is why diversification is key.
How to Supplement the S&P 500
Investing in the S&P 500 through a low-cost index fund can provide a very strong base for most stock portfolios. But to get broad diversification among market caps and sectors, it may help to expand your reach.
Fortunately, there are mutual funds and exchange-traded funds (ETFs) that provide exposure to whatever you may be seeking. An investor who is looking to boost their portfolio by purchasing small-cap stocks can buy shares of an index fund designed to mirror the Russell 2000. If you want to invest more in financial stocks, you can access funds comprising a wide range of banks and financial services firms.
There are also mutual funds and ETFs that offer broad exposure to the entire stock market, including all market caps and sectors. Vanguard’s Total Stock Market ETF and the S&P Total Stock Market ETF from iShares are two popular examples.
A Word About International
Most investors who build their portfolios entirely out of U.S. equities will probably make out fine. America is still the largest and most dynamic economy in the world, after all, but there are many instances when events and growth cycles allow markets outside the U.S. to perform better.
Many financial advisors suggest carving out a portion of your stock portfolio to equities based in Europe, Asia, South America, and emerging markets. There are many mutual funds and ETFs that are designed to take advantage of these non-U.S. opportunities.