Learning how to invest in the S&P 500 is an important step for any investor, new or experienced. As a proxy for the whole U.S. equity market, understanding how to navigate the country’s most popular index gives investors valuable insight into the broader market and economy. Investors who can extrapolate their experience from investing in the S&P 500 to the rest of Wall Street will exercise a penchant for better decision-making and a broader understanding of the national economy.
Many of today’s most prolific investors have enjoyed a very lucrative career by implementing what they learned from investing in the S&P 500, and there’s no reason new investors can’t do the same. That said, now is as good of a time as any to learn how to invest in the S&P 500; doing so may potentially set investors up for years of compounding returns.
What Is The S&P 500?
To understand what the S&P 500 is, investors must first familiarize themselves with the concept of a stock market index. Otherwise known as a stock index, a stock market index tracks a subset of companies traded on Wall Street. Instead of tracking every publicly traded company, stock market indices allow investors to focus their attention on a simple grouping of business, not unlike a cross-section of the market as a whole. That said, the S&P 500 is one of many stock market indices that focuses on a specific set of stocks. As its name suggests, the S&P 500 tracks the performance of 500 large companies listed on stock exchanges in the United States.
Thanks—largely in part—to its size, the S&P 500 is not only one of the most popular indices tracked by investors, but it’s also used as a benchmark to gauge the performance of the entire U.S. stock market. With many leading companies across prominent industries, looking at the S&P 500 typically gives investors a good idea of Wall Street’s overall performance.
According to the Global Industry Classification Standard (GICS), the S&P 500 can be broken up into 11 sectors:
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Energy
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Materials
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Industrials
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Consumer Discretionary
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Consumer Staples
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Health Care
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Financials
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Information Technology
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Communication Services
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Real Estate
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Utilities
With a broad and diverse distribution of sectors, the S&P 500 has been seen as a proxy for the U.S. equity market since its introduction in 1957. Therefore, when investors choose to diversify their holdings within the S&P 500, they are typically betting in favor of the broader market. Subsequently, betting on Wall Street has worked out very well for investors over the long run, which bodes well for anyone getting started today.
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What Is Required To Be Included In The S&P 500?
To be perfectly clear, not every publicly traded company is granted access to the S&P 500. Instead, companies with aspirations of making it onto the S&P 500 (and increasing their exposure to investors) must be selected by a special committee. A select group of individuals is tasked with maintaining the statuesque of the popular index, which uses a number of prerequisites to help make their decisions. In order to even be considered by the committee, companies must:
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Be located in the United States.
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Have an unadjusted market cap of at least $8.2 billion.
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Make at least 50.0% of their shares available to the public.
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Maintain a minimum stock price of at least $1.00 per share.
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File a 10-K annual report.
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Have at least 50.0% of its fixed assets and revenues in the United States.
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Provide at least four consecutive quarters of positive earnings.
As its name suggests, there’s a finite amount of companies allowed on the S&P 500. As a result, the index is recalibrated quarterly, which means companies are constantly being added to and taken off the S&P 500.
Top 10 Companies In The S&P 500
Before we go over how to invest in the S&P 500, here are some examples of the companies you can invest in. Sorted by weight index, here are the top 10 companies in the S&P 500:
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Apple Inc. (AAPL)
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Microsoft Corp. (MSFT)
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Amazon.com, Inc. (AMZN)
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Facebook, Inc. (FB)
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Alphabet Inc. Class A (GOOGL)
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Alphabet Inc. Class C (GOOG)
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Tesla, Inc. (TSLA)
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Nvidia Corp. (NVDA)
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Berkshire Hathaway Inc. (BRK.B)
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JPMorgan Chase & Co. (JPM)
How To Invest In The S&P 500 In 5 Steps
Investing in the S&P 500 is just like investing in the broader equity market. Buying and selling shares of the companies on the index is as simple as making trades through a brokerage. That said, there are investing methods investors may use to concentrate their portfolios on the S&P 500, and nothing else. Let’s take a look at how a new investor can start their own positions in the S&P 500 in as little as five steps:
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Come Up With A Strategy
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Open An Account With A Brokerage
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Research Stocks On The S&P 500
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Invest In Individual Stocks & Funds
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Exercise Patience
Predetermine A Strategy
Any investment strategy begins with just that: a strategy. Before taking any action, investors first need to come to terms with why they are investing, how long they want to invest for, and how much risk they are willing to take on. Answering these simple questions will require a lot of due diligence, but doing so will set the foundation for years of investing in the S&P 500. Understanding exactly what investors need from Wall Street will pave the way for a more clear investment strategy.
Investors on the brink of retirement, for example, will want to pay special considerations to less volatile and more risk-averse stocks. With a smaller investment window, older investors will have less time to make up for any losses, which suggests their portfolios are better off consisting of safer companies. Since retirees will most likely need access to their capital sooner, it’s a good idea to invest in stocks that are less likely to drop. Younger investors, on the other hand, have the luxury of investing in more volatile stocks that exhibit a larger propensity for upside. Fortunately, the S&P 500 awards options for any investor, no matter their investment timeframe.
Open An Account
With a clear investment strategy mapped out, investors will need to open an account with a brokerage, if they haven’t already done so. It is the brokerage, after all, which will allow investors to buy stocks on the S&P 500 in the first place. That said, not all brokerages are created equal; some have inherent advantages over their peers, and vice versa. Some brokerages may charge several fees, while others have made a name for themselves for dropping many of the fees that have become synonymous with trading. Others specialize in exchange traded funds (ETFs) while their counterparts prioritize options trading. Case in point: There are several different brokerages with a number of different things investors need to consider.
Investors should align their services with the brokerages that met their needs the best. Here’s a list of today’s most popular brokerages for investors to start their own research:
Do Your Homework
Now that investors have a clear plan and an avenue to execute their investment strategy, it is time to do a little homework. Instead of simply buying the first stock they set their eyes on in the S&P 500, investors will need to evaluate each company based on a number of merits. The more fundamentally sound a company is, the more it will make a valuable contribution to any portfolio. Here’s a look at some of the most important indicators investors need to take into consideration when investing in the S&P 500:
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Valuation
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Strategy
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Diversification
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Moat
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Risk Aversion
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Earnings
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Debt
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P/E Ratio
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Dividend Yield
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Price-To-Sales Ratio
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Growth
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Management
Alone, each indicator only provides a peek into the company’s performance, but together they can paint a much clearer picture. The culmination of these metrics will help investors determine their optimal investment strategy, and ultimately help them decide which stocks to buy.
Invest In Funds Or Individual Stocks
With a strategy in place and a mind for due diligence, it’s finally time to actually invest. There are two primary ways people invest in the S&P 500: individual stocks and ETFs. In other words, investors may choose to invest in individual stocks they deem worthy of their capital, or they may invest in an exchange-traded fund that tracks the respective index.
Investors who choose to invest in individual stocks are doing so with the sole purpose of beating the index as a whole. While doing so requires more acute attention to detail and an appetite for risk, the rewards for individual stock investors may be more lucrative than those who choose to track the index. Of course, investing in individual stocks requires active involvement in a portfolio. Investors will need to sift through the entire S&P 500 and select the individual stocks they think will help them the most. Again, this strategy coincides with more risk, but the upside is very attractive over longer periods of time.
In addition to individual stocks, investors may choose to invest in ETFs which track the S&P 500. Not unlike individual stocks, there are several ETFs that allow investors to increase their exposure to the entire index. The Vanguard S&P 500 ETF (NYSE: VOO), for example, “seeks to track the performance of a benchmark index that measures the investment return of large-capitalization stocks” in the S&P 500, according to Yahoo Finance. In tracking the S&P, returns and losses will mimic the entire index. Investors who choose this strategy will ultimately find the time is their best friend, as the index has trended upwards for decades. That said, the lack of volatility results in less upside.
Be Patient
As Warren Buffett once said, “The stock market is a device for transferring money from the impatient to the patient.” Simply put, the S&P 500 (and the stock market as a whole) tends to reward patient investors who can buy and hold for long periods of time. That’s not to say the S&P 500 is guaranteed to go up; only that history has shown us it is more likely to go up than down. Therefore any investor tracking the whole index can extrapolate past performance into future expectations.
Should You Invest In The S&P 500?
Owning stocks and exchange-traded funds associated with the S&P 500 has proven to be a lucrative strategy for investors with long-term investment horizons. Historically, long-term investments in the S&P 500 have worked out well for those who prove patient enough. According to Investopedia, “the average annual return since its inception in 1926 through 2018 is approximately 10%–11%.[cite] The average annual return since adopting 500 stocks into the index in 1957 through 2018 is roughly 8%.” That is, of course, if investors attempt to mimic the returns of the S&P 500 with an ETF or mutual fund. The returns will vary for investors who choose to invest in individual stocks of their own. It is entirely possible to beat the returns of the index, but investing in individual stocks will increase risk exposure.
Benefits Of Investing In The S&P 500
Investors who learn how to invest in the S&P 500 may be granted access to the following benefits:
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Stability: The S&P 500 consists of large-cap stocks, which suggests an inherent degree of success. At the very least, to become a large-cap stock, a company has to have already exhibited a relatively large amount of success. Otherwise known as blue-chip stocks, large-caps are large for a reason. Therefore, investing in them through the S&P 500 means investors are putting their capital in stable companies.
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Diversification: The S&P 500 is made up of 11 sectors, which means it consists of a wide swath of industries. Those who invest in a fund that tracks the S&P 500 will, therefore, be putting their money in each sector. Doing so immediately diversifies holdings and reduces risk exposure.
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Proven Track Record: As an index made up of bluechip stocks, the S&P 500 has produced an average annual return of about 8.0% since 1957. While that number will vary from year to year, the average return should provide some investors with peace of mind.
Disadvantages Of S&P 500 Investing
Not unlike every investment strategy, learning how to invest in the S&P 500 also coincides with some disadvantages:
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Lack Of Mid- And Small-Cap Companies: By nature, the S&P 500 is made up of large-cap stocks (and only large-cap stocks). While the composition makes for a less volatile index, it also eliminates the potential to invest in small- and medium-cap stocks.
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No International Exposure: Again, the selective nature of the S&P 500 prevents many companies from making the cut. The prerequisites to be included on the index immediately prevent a number of equities from joining the ranks. International stocks, in particular, are left of the index, along with other equities.
Summary
Learning how to invest in the S&P 500 is less a practice in trading and more of a broader understanding of the entire market. As the most popular proxy to Wall Street, the S&P 500 does its best to mimic the returns of all U.S. indices. Therefore, a bet on the S&P 500 is almost like a bet on the broader U.S. economy. Nonetheless, the S&P 500 has historically increased over long periods of time. Investors who partake in the index now will most likely be happy they got in earlier than later.
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