Standard and Poor's 500 index is a list of the largest publicly-traded American companies, in terms of their value. It's a stable list. It doesn't change much. It also measures the health of the American economy as a whole, across multiple market sectors and industries.
What is the S&P 500?
The S&P 500 is often seen as a barometer for the stock market as a whole. The Standard and Poors rating service maintains a list of the 500 largest American companies by market capitalization. In other words, the 500 largest US companies based on the total value of their stock price times the number of outstanding shares make up the S&P 500 index.
One criticism of the S&P 500 index is that it focuses on the largest and, almost certainly, most stable of American companies. While smaller companies are often much more volatile, their potential for explosive growth is also greater. Fear not; Standard and Poors has several indexes.
What is the S&P 500 Index Fund?
As What is an Index Fund? suggests, the S&P index fund is a single fund you can buy from a stock broker which represents one distinct unit of the underlying index. In other words, if the index consisted of 10% GE, 20% Apple, 40% Coca-Cola, and 30% Ford, one share of the index fund would have the same ratio. Its easy to calculate your fractional ownership of these companies. Yes, "fractional ownership"—in effect, you are buying partial shares of stock in many businesses.
Because the specific makeup of the index changes rarely, the fund is easy to explain and buy and hold. It's also so popular that it gets reported in financial news almost as often as the Dow index or the NASDAQ index, so you can easily get a sense of how your investment is doing even without diving into details.
Because of its broad nature, weighed a little toward the conservative side, the S&P 500 index is the de facto measurement of market performance. When investors talk about beating the market, they mean they're trying to get better returns than if they'd just bought the index and left things alone.
You can beat the market, but you'll have to work for it, especially when you take into account trading fees, inflation, and taxes.
How to Invest in the S&P 500
In terms of simplicity of investment, you can't beat a good index fund. In the most popular index funds, costs are low, charges are minimal, rebalancing isn't your problem, and you can buy and forget. If you have only one index fund in your portfolio—if your only exposure to stocks is a single index fund—the S&P 500 is a good investment. Vanguard's VFINX is the fund to beat. You can even invest in it without much money and you can invest without a broker; Vanguard requires $1000 for retirement funds and $3000 for other funds. Vanguard's transaction fees are minimal, especially for their low cost index funds, so once you've saved up that much, you're in. If you're looking for a simple answer about which fund to invest in, start here!
Some of the criticisms of the S&P 500 apply to funds based on that index:
- It's an American-centric list of companies (so you'll miss out on good opportunities in emerging markets)
- It has a bias toward large-cap businesses (asset allocation skewed away from mid-cap businesses, which are riskier but tend to have greater returns when they have good returns)
- It's easy to game briefly when changes to the index occur (infrequent)
None of these are deal breakers. If you can add only one thing to your portfolio—an ETF or a REIT or a mutual fund or a bond fund or an index fund—pick this index fund. Its potential outweighs its weaknesses. Sure, if the lumber fields of Canada have a record boom, you might miss out on that opportunity, or if small and medium businesses in the US have a record year, you won't see that, but the historical returns of the S&P 500 show a nice blend of long-term stability and growth. It's diversified across sectors and industries, which exposes you to more opportunities and minimizes more of your risks. You'll have to work hard to beat its returns on your own in active trading. (Or you could give all of your money to a hedge fund manager and hope to get a good return before he or she goes to prison. Not every hedge fund is a scam, but they tend to be super risky.)
Trendshare's writers have invested heavily in this index fund to great satisfaction, but they also also supplement their portfolios with individual stocks from much smaller companies. In practice, those investments have turned out better, but again—that's more risk and work and research.
Buying index funds is a great way to start investing, and Vanguard's S&P index fund will serve you well. If you're ready to start investing in stocks, smart money can wisely start with VFINX, the standard-setting low-cost index fund that tracks the S&P 500. See how to invest in index funds for more information.
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