The Standards and Poor’s 500, or S&P 500, is one of the world’s most widely tracked stock market indices. Containing 500 of the largest publically traded US companies by market capitalisation, the index is commonly used as a performance benchmark for investment portfolios or as a gauge of the general health of the US economy.

The S&P 500 is also a weighted index. As such, the largest companies have a more significant impact on its overall performance. It’s also worth pointing out that due to some firms having a dual-class share structure, there are, in fact, 503 stocks contained within its ranks.

The history of the S&P 500 dates back to 1923 when Standard & Poor’s introduced a series of indices covering 26 industries. However, the index as we know it today wasn’t formed until 1957. And is now maintained by a joint venture called S&P Dow Jones Indices, which is majority owned by S&P Global Inc. S&P Global is also a constituent of the S&P 500 index.

How does the S&P 500 work?

As previously said, the S&P 500 index is a free-float market-capitalisation-weighted index. It contains the largest 500 enterprises, including the 30 businesses that make up the Dow Jones Industrial Average index.

As of 19 January 2023, it has a combined market capitalisation of $32.60trn. Compared to the $40.51trn of total US equities, the S&P 500 represents roughly 80.5% of the total US stock market. This is the main reason why it’s such a popular proxy for the performance of the US stock market as a whole.

Criteria for joining the S&P 500 index

While size is important, other criteria must be met for a business to be included within the index.

• The company must be an American business. 
• It must have a market cap of at least $8.2bn.
• It must have at least 50% of its shares outstanding available for public trading. 
• Its shares must be listed on either the New York Stock Exchange, Nasdaq Exchange, or Chicago Board Options Exchange.
• Its shares must have sufficient trading volume to be highly liquid.
• Its combined net earnings over the last four quarters must be positive.

If a company already in the index no longer meets these criteria, it will be removed and replaced by the next most appropriate stock. The addition and removal of businesses occur every time the index is rebalanced on the third Friday of March, June, September, and December.

How is the S&P 500 index calculated?

The level of the S&P 500 is calculated based on the combined market capitalisation of its constituent members. As a weighted index, not every stock has the same influence on the price. The weighting of each company is calculated by comparing the firm’s market cap to the total market cap of the S&P 500.

In reality, the index’s total value is also affected by a Divisor factor controlled and moderated by S&P Dow Jones Indices. This factor is revised at regular intervals and exists to keep the index consistent when certain events take place.

For example, during a merger or acquisition of an S&P 500 stock, the index could suffer a significant drop if the replacement company isn’t roughly the same size (which is usually the case). The factor is subsequently altered to keep the index stable and adjusted over time to ensure the reported index level is understandable.

Another purpose for the Divisor factor is to prevent index manipulation by businesses. When a company executes a share buyback scheme, it causes its market capitalisation to increase and, therefore, the weighting within the S&P 500. As index funds track the performance of the S&P 500 by replicating its portfolio, this increased weighting invites additional investment, which pushes its market cap even further along with its weighting in an artificial and unsustainable loop.

Top 10 S&P 500 stocks

Below are the top 10 S&P 500 stocks in order of market capitalisation as of 30 December 2022.

What is the average return on the S&P 500?

As previously mentioned, the S&P 500, in its current form, was first launched in 1957. And since then, the index has grown considerably. The total return (capital gains + dividends) over the last 65 years is approximately 55,269%. That’s the equivalent of a 10.2% annual return on investment.

Based on these figures, a $1,000 investment in 1957 would be worth roughly $553,690 today. But the historical performance of the index changes depending on which time frame an investor is using.

Due to certain tax laws, the US stock market has historically been more fond of using share buybacks to return excess capital to shareholders. However, multiple companies within the S&P 500 pay shareholder dividends, with yields ranging from 6.7% to 1.07%. As of 17 January 2023, the average dividend yield of the S&P 500 stood at 1.68%.

S&P 500 vs other indices

The S&P 500 is one of many equity indices in the stock market. Others include the Dow Jones Industrial Average and Russell 2000 in the United States. Another popular index across the pond in the United Kingdom is the FTSE 100. But how do these indices compare?

S&P 500 vs FTSE 100 

Similar to the S&P 500, the FTSE 100 index contains the largest 100 largest British stocks by market capitalisation listed on the London Stock Exchange. It’s also a market cap-weighted index. However, the S&P 500 has historically been more volatile.

The volatility difference is made apparent when looking at their respective performances during the 2022 stock market correction. The S&P 500 suffered a 19.4% decline over the 12-month period. By comparison, the FTSE 100 was flat. But this stability comes with historically inferior returns. On average, the UK index has delivered a total annual return of 7.15% versus the S&P 500’s 10.2%.

S&P 500 vs Dow Jones 

The Dow Jones is an index of 30 large businesses listed on US stock exchanges. Unlike the S&P 500, the Dow Jones is a price-weighted index with more limited coverage. It’s one of the oldest and among the most followed indices globally. The index could not escape the 2022 bear market as the index is down over 8%.

S&P 500 vs Russell 2000

The Russell 2000, like the S&P 500, is a market capitalisation-weighted index. Unlike the S&P 500, it comprises exclusively of 2,000 small-cap stocks. The index, like the general market, plunged this year. Russell 2000 is down over 21% in 2022 and, in the past five years, up 14.70%. FTSE Russell, a subsidiary of the London Stock Exchange, maintains the index.

Is the S&P 500 a good investment?

Historically, the S&P 500 has delivered solid returns for long-term investors. And it’s why the index is one of the most widely tracked benchmarks by investors and index funds. However, there are some caveats to consider.

Advantages

• Instant Diversification – An investor has indirectly bought shares in every company within the underlying index by owning an index fund. Consequently, a portfolio is automatically diversified across multiple businesses, industries, and geographies.
• Low Fees – Index tracker funds are almost always passively managed. Lower management fees come with a smaller expense ratio and, subsequently, deal less damage to total investment returns. Investing through an index fund is also typically more cost-effective than buying shares of each individual stock in an index.
• Notable Growth – The index has historically provided double-digit annual returns. And over long time periods has led to the creation of impressive volumes of wealth for patient investors.

Disadvantages

• Sector Concentration – The majority of growth delivered in the last decade primarily stems from technology stocks. Investing in an S&P 500 index fund consequently results in being potentially overly concentrated in a single sector. This risk factor is one of the main reasons why the index fell hard in the 2022 stock market correction.
• Volatility – Sector concentration also opens the door to increased levels of volatility that can cause large fluctuations within an investment portfolio.
• No Control – Index tracker funds do not have a stock selection criteria beyond a business being a constituent of the index being tracked. As such, it’s possible for investors to indirectly own shares in companies that may not align with their ethical or moral values. For example, there are several tobacco stocks within the S&P 500. However, there is no way to avoid these businesses when buying shares in an index fund.

Whether the S&P 500 is a good investment largely depends on the individual investor. Everyone has different investing objectives, risk tolerances, and time horizons that must be considered before making an investment decision.

S&P 500 index sector weightings

Companies within the S&P 500 cover a broad range of industries with some concentration within the Technology, Healthcare, and Financials sectors.

List of all S&P 500 companies

The bottom line 

Legendary investor Warren Buffett has long recommended investing in low-cost S&P 500 index funds. After all, the index has generated impressive returns that most novice investors would likely struggle to beat when picking individual stocks. However, like any investment, there is always an element of risk that needs to be considered.

This article contains general educational information only. It does not take into account the personal financial situation of the reader. Tax treatment is dependent on individual circumstances that may change in the future, and this article does not constitute any form of tax advice. Before committing to any investment decision, an investor must consider their individual financial circumstances and reach out to an independent financial advisor if necessary.