The S&P 500 Index: Staying invested in the US economy
📈 What is the S&P 500?
Back in 2008, Warren Buffett issued a challenge to hedge fund managers. He bet that an index fund that simply tracked the S&P 500 index would, over time, outperform a portfolio of individual stocks hand-picked by industry experts. After almost 10 years, the challenge was over – the S&P 500 won.
If you’re at all interested in investing, it’s likely that you’ve come across the S&P 500. You might have even read investment strategies focused exclusively on it. From the seasoned hedge fund manager to the personal finance beginner, the S&P 500 is important to keep track of.
But what is it exactly?
To put it simply, think of the S&P 500 as an indicator which, at a glance, gives you a good idea of the current health of the United States economy. We’ll dive deeper into how it does this below, but let’s summarize what you need to know first:
🔑 Key takeaways
- The S&P 500 is an index that tracks the share performance of 500 leading American companies. Its index level, which is the figure you see in financial news headlines, is calculated primarily based on the share price of each company in the index.
- The S&P 500 can be seen as a benchmark of the US stock market at large. While the companies listed may have a global presence, Investing in the index is, in a way, investing in the country itself. Such an investment would be inherently diversified across a number of industries.
- Historical data has shown that the S&P 500 trends upwards, and has always bounced back after downturns. Staying invested pays off.
- Certain exchange-traded funds replicate indexes like the S&P 500; this is a low-cost method to diversify your investments. Our Flexible Portfolios offer an easy way to invest in the S&P 500, and for a single ETF portfolio, you’ll be paying a management fee of only 0.3% p.a.
📖 A brief background
Standard and Poor’s (this is where the ‘S&P’ comes from), a credit rating agency, launched the S&P 500 index back in 1957. It was designed to take stock of, well, stocks. Specifically, the performance of five hundred American companies (this is where the ‘500’ comes from).
To be eligible for inclusion in the index, a company needs to meet certain requirements – but only the biggest 500 companies by market capitalisation make the cut. This list is managed by Standard and Poor’s, and is updated on a periodic basis. For example, tech giant Apple was added in 1982, and its weight in the index has grown over time, while motorcycle maker Harley-Davidson was removed in 2020 when it became too small.
🧮 How it’s calculated
Calculating for the S&P 500, while relatively simple, takes a lot of data. Mainly, it takes into account share price and number of shares publicly available for all of its constituents. Multiplying those two figures together is how you would calculate the market capitalisation for a company. As companies perform better, their share prices are driven up by the market, which is in turn reflected in the index. This is why it’s a measure of stock performance.
The S&P 500 is also a capitalisation-weighted index – this just means that larger companies have a greater impact on the index level. For example, stock price changes in Apple, one of the largest companies included, heavily affect the S&P 500. As individual stock prices fluctuate throughout each trading day, the S&P 500 is continuously updated. A single figure, the index level, is what’s presented – this is the number you see in financial news headlines.
📈 Staying invested in the US economy
When you choose to invest in the S&P 500, you’re choosing to invest in the US stock market at large. This includes all of its ups and downs. Even then, investing in the S&P 500 from 1992 to 2022 – which means staying invested and reinvesting dividends for the entire period – you would have achieved returns of 9.6% per year (ignoring inflation).
If that’s not enough to convince you, let’s put that into numbers: if you (or your parents) had invested $1,000 in the S&P 500 in 1992 and stayed invested for 30 years, that amount would have grown to become $17,318.23. A 30 year investing period like this would be ideal if you’re planning for retirement.
The benefit of staying invested, especially in stocks, reveals itself over the medium to long term. Consider that in the past three decades we’ve seen the dot-com bubble, the Great Recession, and the coronavirus pandemic. Yes, staying invested is that powerful.
The graph above is a clear example of the power of long-term growth – and the importance of staying invested to reap that long-term growth. Even as recessions come and go, notice that the index always bounces back. This is because the US economy (and the world, for that matter) always bounces back. Staying invested also avoids the costs involved with buying and selling, which can add up.
To summarize: why try to beat the market when you can use it to your advantage.
📊 Diversification across industries
The S&P 500 is broad. It covers roughly 80% of the US stock market. In such a large collection of companies, there is inherently great diversity: from technology to banking and healthcare to utilities. This makes the S&P 500 one of the best barometers of the US economy itself.
This diversity benefits the performance of the index. Let’s imagine a scenario where the financial sector is facing a crisis, and the share prices of US banks are falling. For the S&P 500 however, the financial sector only makes up 12.5% of the overall index. Sectors like healthcare and utilities, while potentially affected from the fallout, would avoid direct exposure.
In this manner, diversification across sectors prevents over-exposure to any one industry. As different sectors behave differently under different market conditions, the index as a whole is able to ride out volatile periods. Investing in the S&P 500 thus shields you from too much risk of any one sector performing poorly, while still allowing you to participate in the growth of the overall economy. As the saying goes, don’t pull all your eggs in one basket.
💲 How to invest in the S&P 500
To be clear, you can’t invest in the S&P 500 index itself, it’s just a list of companies. You could buy shares in all 500 companies listed on the index. But that’s a lot of work. And would involve a lot of money. Thankfully, there are easier ways.
We recommend exchange-traded funds (ETFs). ETFs are portfolios of assets, such as stocks, designed to track a variety of themes or asset classes, like a sector, or an index. To put it simply, investing in an ETF that tracks the S&P 500 would be similar to buying each stock listed on the index. Except far simpler and more cost-efficient.
Our Flexible Portfolios offer the convenience of selecting single ETFs – you’re able to pick a single S&P 500 ETF to invest in.
In the case of Flexible Portfolios, it’s currently represented by the iShares Core S&P 500 ETF (IVV US). A Flexible Portfolio composed of this ETF accurately tracks the performance of the S&P 500, tapping into broad, market-representative diversification. Such an investment also capitalizes on robust medium to long-term capital appreciation. That is to say, as these US companies grow, so too does the value of your investment.
Our Flexible Portfolios are also cost-efficient: selecting to only invest in the S&P 500 costs just 0.3% in management fees p.a. Here’s a step-by-step guide. But these portfolios aren’t limited to the S&P 500; they’re designed to let you easily customize your investments to target various asset classes. Choose a Japanese ETF to capture growth there, or add exposure to gold. These portfolios give you the freedom to invest however you feel most comfortable. They’re just that flexible.