How to Invest in the S&P 500



The S&P 500 index tracks the largest companies in the United States. Its stocks are curated by the S&P Index Committee, which selects companies based on a number of factors, including market capitalization, sector allocation, and liquidity.

But what if you’re looking to invest in S&P 500 stocks and don’t have the temperament to sift through and analyze 500 companies? You may want to consider an S&P 500 index fund or exchange-traded fund (ETF) to help you gain exposure to all those stocks.

Vanguard introduced individual investors to the U.S.’s first mutual fund in 1976. It was designed to mimic the S&P 500 Index. The first ETF was introduced by a subsidiary of AMEX 17 years later, which also allowed investors to begin tracking the index.

Nearly all major brokerages and fund companies now offer some type of S&P 500 fund. Investors may access these funds through financial advisors, full-service brokers, or discount brokers. If you need some guidance, we break down some of the basics of S&P 500 index investing through ETFs and mutual funds. All figures are as of April 2022, unless otherwise indicated.

Key Takeaways

  • The S&P 500 is an index that tracks 500 of the largest U.S. companies based on their market capitalization.
  • You can’t actually invest in the index but you can in an index fund or ETF.
  • An S&P 500 Index fund can help your portfolio gain broad exposure to the constituent stocks in the S&P 500 index.
  • Index mutual funds and ETFs maintain a strategy of passive index replication, affording investors broad access to all of the securities within the given index.
  • Many funds that track the S&P 500 generally have very low management fees.

What Is the S&P 500 Index?

The S&P 500 Index was launched in 1957 as the first U.S. market-cap-weighted equity index and is widely regarded as the best single gauge of large-cap U.S. equities. As the most influential equity index in the world, the index has trillions of dollars indexed or benchmarked to it.

The index is traditionally made up of 500 of the leading U.S. companies, although that number may fluctuate. The S&P 500 represents approximately 80% of available U.S. market capitalization. The median market cap of the stocks held in the index is $31.7 billion, with the highest being $2.85 trillion.

S&P 500 stocks reflect the U.S. economy’s growth drivers to a significant extent. For example, the top 10 constituents of the S&P 500 by index weight are:

  1. Apple
  2. Microsoft
  3. Amazon
  4. Tesla
  5. Alphabet (class A shares)
  6. Alphabet (class C shares)
  7. Nvidia
  8. Berkshire Hathaway
  9. Meta Platforms
  10. UnitedHealth Group Inc.

These mega-cap stocks, which dominate the U.S. and global markets, are mostly concentrated in three sectors:

  • Information technology, the largest sector by weight in the S&P 500 index, at 28%
  • Consumer discretionary, the third-largest by weight, at 12%
  • Communication services, the fifth-largest at 9.4%

Together, these three sectors account for close to 50% of the S&P 500, reflecting the dominance of technology and related sectors in the U.S. economy. Other large sectors in the S&P 500 are health care at second with a 13.6% weight and financials at fourth with 11.1%.

The top five sectors together constitute almost three-fourths of the S&P 500. The other six sectors—industrials, consumer staples, energy, real estate, materials, and utilities—combined make up the remaining 25.9% of the S&P 500.

An estimated $13.5 trillion is indexed or benchmarked to the S&P 500, with index funds and ETFs comprising about $5.4 trillion of this total.

Index ETFs vs. Index Mutual Funds

You cannot invest directly in an index because it’s simply a measure of the performance of its constituent securities. What you can do is invest in an index through ETFs and index funds that try to replicate the performance of specific indexes.

ETFs focus on passive index replication, giving investors access to every security within a particular index. So an S&P 500 ETF exposes the investor to all of the stocks in that index. Index ETFs are generally low-cost and trade throughout the day just like stocks. Consequently, they are highly liquid and subject to intraday price fluctuations.

S&P 500 index funds tend to have slightly higher fees than ETFs because of higher operating expenses. Furthermore, because a mutual fund has a structure that differs slightly from that of an ETF, investors can only buy it at the day’s closing price, which is based on the fund’s net asset value (NAV).

The following are examples of index ETFs and mutual funds that are popular with investors:

  • The largest S&P 500 ETF is State Street Global Advisors’ SPDR S&P 500 ETF (SPY), which had $402 billion in assets under management (AUM). SPY was launched in January 1993 and was the very first ETF listed in the U.S.
  • Index investing pioneer Vanguard’s S&P 500 Index Fund was the first index mutual fund for individual investors. The Vanguard 500 Index Fund Admiral Shares (VFIAX) was the largest index fund, with total assets of $808 billion.

Buying an S&P 500 Fund or ETF

If you want an inexpensive way to invest in S&P 500 ETFs, you can gain exposure through discount brokers. These financial professionals offer commission-free trading on all passive ETF products. But keep in mind that some brokers may impose minimum investment requirements.

S&P 500 index funds also trade through brokers and discount brokers and may also be accessed directly from the fund companies. You may want to manage your portfolio through an advisor or a broker, or you may prefer to manage a portfolio of funds that are all housed within a specific mutual fund provider.

If you have the option, you may also access ETFs and mutual funds through employer 401(k) programs, individual retirement accounts (IRA), or roboadvisor platforms.

What to Look for

Whether you’re a novice or an experienced investor, there are a few things you’ll have to consider before you lay down any money. If you don’t have an investment account, be sure you find a brokerage or investment firm where you can purchase shares of your chosen ETFs and/or mutual funds.

Cost is a big factor when it comes to any investment. The expense ratio for ETFs is the overall annual cost paid to the fund manager by investors. An expense ratio between 0.5% to 0.75% is considered good. Be sure to approach anything greater than 1.5% with caution as funds that charge these expense ratios are considered high.

Many mutual funds come with sales loads or commissions that are paid to the fund managers by investors. These may be classified as front-end or back-end loads. The first is charged when you buy the fund while the latter is charged when you sell your fund shares. Funds that are sold directly by the investment provider don’t come with a load.

Although cost is an important factor, don’t forget to look at the performance of the fund. You can find the fact sheet for every investment on the website of the company offering the ETF or the mutual fund.

How to Invest

Choosing the right funds is half the battle. Knowing how to invest in them is the next step. Make a note of the name and ticker symbol of all the funds that you’re interested in as you’ll need this information when you begin purchasing shares.

Then determine the amount of capital available to use. This can help you figure out how much money you can afford to pay your brokerage firm when it comes to fees and commissions. If you don’t have an account, look for one that meets your criteria. If you don’t have a lot of capital, look for a firm that offers low-fee trading options.

Once your account is set up, you can begin investing in your funds.

Advantages and Disadvantages of Investing in the S&P 500

If you’re still on the fence about an index ETF or fund, consider how long it would take for you to do your research on each stock. After all that time and effort, you may find the investment performance may be well below the results that could be obtained merely by investing in an S&P 500 index fund or ETF because it is extremely difficult to beat the market.

Legendary investor Warren Buffett has some sage advice for wannabe stock pickers. Buffett reiterated on multiple occasions that the average investor is best served by investing in an S&P 500 index fund, and not by trying to pick stocks. At the 2021 Berkshire Hathaway AGM, Buffett hammered home this point by noting that of the 20 largest companies in the world by market capitalization in 1989, not one remains among the top 20 today.

Investing in an S&P 500 ETF or fund is a single-ticket solution to get exposure to many of the world’s most dynamic companies in the largest economy. It eliminates having to spend countless hours analyzing and picking stocks. And the index is a consistent performer over the long term. In the 10 years ended March 31, 2022, the S&P 500 generated an annualized return of 14.64%.

Below, we’ve listed some of the most common pros and cons of investing in this index.

Advantages

Some of the benefits of investing in the S&P 500 include:

  • Exposure to the world’s most dynamic companies: Investing in the S&P 500 gives an investor exposure to some of the world’s most dynamic companies, such as Apple, Amazon, Google, and Tesla.
  • Consistent long-term returns: Although returns in any single year can vary widely over a long-term period, the S&P 500 has been a consistent performer.
  • Intricate analysis not required: Investing in the S&P 500 through an ETF or index fund means that you do not have to spend hours analyzing and picking stocks in a futile attempt to beat the market.
  • Can serve as a core holding: S&P 500 index funds and ETFs are very liquid and trade with tight bid-ask spreads. This makes S&P 500 funds and ETFs ideal as a core holding for most investment portfolios and makes them suitable for advanced strategies like covered calls and hedging.

Disadvantages

The following are some of the main drawbacks of investing in the S&P 500.

  • The index is dominated by large-cap companies: The S&P 500 is dominated by large-cap companies, with its 10 biggest constituents accounting for almost one-third of the index. This means that the S&P 500 index does not have any exposure to small-cap and mid-cap stocks that may have the ability to grow much faster than large-cap stocks.
  • The index has risks inherent in equity investing: The S&P 500 has risks inherent in equity investing, such as volatility and downside risk. For example, the index lost almost one-third of its value in the space of a few weeks in March 2020. Newer investors may find it difficult to tolerate such volatility.
  • Only includes U.S. companies: The S&P 500 only includes U.S. companies and excludes companies in other parts of the world, such as Asia and Europe.
Cons

  • Purely large-cap play

  • Equity risk

  • U.S.-centric approach

Advancing Beyond a Passive S&P 500 Index Fund

If you want an advanced approach to S&P 500 fund investing, consider smart beta indexes. These options have lower costs and offer the advantage of fundamental or customized investing. Examples of such funds include the AAM S&P 500 High Dividend Fund (SPDV) and the S&P 500 Equal Weight Index Fund (RSP). You can also target index segments that offer capital appreciation potential, with funds like the SPDR sector series or dividend-focused funds.

Many fund managers also offer active S&P 500 funds, which focus primarily on S&P 500 names but actively trade names beyond those strictly found in the index. There are also leveraged funds, which offer a simplified hedging approach. Bullish leveraged funds use leverage to multiply the return of the S&P 500 when it performs well. Bearish leveraged funds short the S&P 500 to pull in positive returns when the index falls.

Should I Invest in the S&P 500 Through an Index Fund or ETF?

Whether you invest in a mutual fund or ETF depends on whether you want the intraday liquidity of an ETF. For some investors, the ability to trade the S&P 500 intraday, like stocks, is the main reason for choosing an ETF over an index fund. If intraday liquidity is important to you, consider an S&P 500 ETF over an index fund.

How Much Does It Cost to Invest in the S&P 500?

The difference in fees between S&P 500 index funds and ETFs these days is marginal. For example, some of the biggest and most popular S&P 500 ETFs have a very low expense ratio. Vanguard’s S&P 500 ETF (VOO) has an expense ratio of 0.03%, while the Vanguard 500 Index Fund Admiral Shares (VFIAX) has an expense ratio of 0.04%.

Do S&P 500 ETFs and Funds Pay a Dividend?

S&P 500 index ETFs and mutual funds pay dividends to the constituent companies. The S&P 500 index has a dividend yield of about 1.41%.

Is an S&P 500 ETF or Fund a Suitable Investment for a Non-U.S. Investor?

Depending on their risk tolerance, investors outside the U.S. should generally have some exposure to the U.S. equity market as part of a diversified portfolio. For such overseas investors, the obvious currency risk (which can be hedged) is more than offset by the stellar long-term performance record of the S&P 500.

What Are the Criteria for a Company to Be Included in the S&P 500?

Some of the criteria for a company to be included in the S&P 500 are:

  • It must be a U.S. company.
  • It should have an unadjusted market cap of at least $14.6 billion and a float-adjusted market cap of at least 50% of that minimum threshold.
  • It must have positive as-reported earnings over the most recent quarter as well as over the four most recent quarters combined.
  • Its ratio of annual dollar value traded to the float-adjusted market cap should be at least 1.00 “at the time of addition to the Composite 1500” and stock should trade a minimum of 250,000 shares in each of the six months leading up to the evaluation date.

The Bottom Line

Investing in an S&P 500 index fund is a great way to diversify your portfolio. Whether you choose an ETF or a mutual fund depends on how much you can afford and what your goals are for the future. Regardless of which option you choose (or if you choose both), you’re likely to see some consistent returns. Make sure you have the right brokerage account for your needs so you’ll save on fees and commissions.



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