When you turn on NPR, NBC, or CNN, you’re likely to hear the commentator mention, at the top or bottom of every hour, the performance of a market index.
The S&P 500 is a particularly useful measure because it includes 500 companies, which is a large, representative swath of the overall U.S. stock market. The Dow Jones covers just 30.
What is the S&P 500 index? Below, an exploration into the popular market index, along with a look at ways to invest in the S&P 500.
An Explanation of the S&P 500 Index
The S&P 500 is often considered the best measure of large U.S. company stock. These are called large- and mega-cap stocks—“cap” being short for capitalization. Capitalization is a measure of the value of a company’s stock. In the stock market, it’s how size is measured.
The index describes itself as including 500 “leading” companies. It uses the word “leading” as opposed to “biggest” because there is more to the criteria for inclusion than just size. That said, many of these companies are household names and true giants in business.
The S&P 500 index includes about 80% of the U.S.’s market capitalization, which is another way to say that it measures 80% of the market by size.
It includes companies that are the biggest players in the U.S. economy, many of which bring in business from across the globe.
The index does not include every stock available in the US. Small- and mid-size companies are typically excluded from the S&P 500. But there are plenty of indices that measure just these markets, or the entire U.S. stock market, including both big and small companies. More on the different indices, below.
In fact, there are thousands of indices that measure just about every investable market in the world. It is important to understand that an index simply measures the very market that it was built to measure—nothing more, nothing less.
How the S&P 500 Stacks Up
The first version of the S&P 500 index was created in 1923 by Henry Barnum Poor’s company, Poor’s Publishing. It began tracking 90 stocks in 1926. Standard & Poor’s was officially founded in 1941, when the company merged with Standard Statistics, with the goal of being a leading provider of financial information and analysis.
The modern S&P 500 index was created in 1957. At the time, it was the first U.S. market cap–weighted stock market index.
Market cap–weighted means that more valuable companies have more power to move the index than a smaller company. For example, a 5% increase in the value of Microsoft stock would have a more pronounced impact on the market index than a 5% increase in Ralph Lauren stock, which is much less valuable overall, having a much smaller market cap.
S&P 500 vs. DJIA
Compare the S&P 500 to the Dow Jones Industrial Average. The DJIA or “the Dow” as it is often called, has been around for longer than the S&P 500—it was created in 1896. To this day, the DJIA measures only 30 U.S. “blue chip” stocks that are considered anchors of the American economy.
Because it only measures the performance of 30 companies, it is sometimes considered a less representative measure of U.S. stock market performance. Further, the DJIA uses a somewhat complicated price-weighted calculation methodology.
Price-weighting is sometimes criticized, as the price of a stock is not indicative of a company’s overall value. For example, Nike stock is currently trading around $90 and has a market capitalization of $140 billion. Goldman Sachs stock trades for about $180 and has a market capitalization of $63 billion.
By this measure, Nike is more than twice the size of Goldman Sachs. But because Goldman Sachs stock trades at a higher price than Nike stock—a function of how many stocks are made available—it has more power over the index.
The stocks held in the DJIA are selected by a committee. Market cap, or size, of a company is considered, but that’s not all. “A stock typically is added only if the company has an excellent reputation, demonstrates sustained growth and is of interest to a large number of investors,” according to the index . All of the stock held in the DJIA are held in the S&P 500.
If the S&P 500 and the DJIA win the market index popularity contest in the U.S., the Nasdaq comes in a close third. The Nasdaq is often used as a measure for technology stocks.
What about the Nasdaq?
The Nasdaq is an exchange, and the Nasdaq index tracks the stocks (and other securities) listed on its exchange. An exchange is a digital marketplace for stocks or other securities—the New York Stock Exchange (NYSE) and the Nasdaq are the two top shops in the U.S.
For companies listing their stock for sale on an exchange, the Nasdaq has long been a go-to spot for technology heavyweights. The Nasdaq is not exclusive to technology companies, but due to its heavy weighting in the tech sector, it is often considered a bellwether for technology stock performance.
Another popular U.S. stock market index is the Wilshire 5000, which represents the entire U.S. stock market. Currently, the Wilshire 5000 consists of 3,473 stock holdings.
The Russell & Others
For small-cap stocks, the Russell 2000 is often a top choice. The index tracks the 2,000 smallest companies trading in the U.S. stock market. The Russell 1000, on the other hand, measures the 1,000 largest stocks. The Russell 3000 contains nearly all U.S. stocks.
There are a whole lot of indices in the U.S., and tons more internationally. Most countries have their own market indices. It is also possible to find indices that niche down to smaller subsets of the stock market, such as by industry or other criteria (such as “green” companies). There are so many market indices out there, it would be impossible to list them all.
Popular global indices include the MSCI World and the MSCI ACWI, which stands for “all country world index.” The latter includes emerging markets like Brazil and China, and the former includes only developed markets, such as the U.S., Germany, and Japan.
Performance of the S&P 500
The S&P 500 index has had a pretty incredible historical run. It has grown significantly over time, but not without some hiccups along the way. One could certainly never describe the trajectory of the S&P 500 index as boring—but hey, that’s the stock market.
The S&P 500 has annualized approximately 10% over time. Said another way, the stock market’s long-term performance boils down to about 10% growth per year.
This can be somewhat misleading, though. This does not mean that the S&P 500 grows by a neat and tidy 10% each year. Instead, 10% is an average. Some years experienced much larger growth than this, and there were other years where growth was significantly smaller, or even negative.
Over time, investors have witnessed several market crashes as measured by the S&P 500, such as the dot-com bubble in the early 2000s and the market crash of 2008.
For example, the S&P 500 returned -37% in 2008 and +27% in 2009. Though long-term averages have been favorable, it’s certainly not without short-term volatility.
What Companies Are in the S&P 500?
The S&P 500 index currently consists of 505 holdings, selected by a committee. In general, the S&P 500 seeks to limit turnover in the index.
The most influential companies in the U.S. are included in the S&P 500 index. Because the index is market cap–weighted, the companies included could change over time.
To be included, companies must be headquartered in the U.S. with a market cap of $8.2 billion or greater. There are additional requirements for trading liquidity and company earnings.
The S&P 500 aims for a representative breakdown across industries, or “sectors,” as they’re called in investing parlance. Said another way, if technology makes up 25% of the market measured by the S&P 500, then the index should reflect that.
Currently, technology, health care, and financials are the three largest sectors represented by the S&P 500 index. Other sectors include communication services, consumer discretionary, industrials, consumer staples, utilities, real estate, energy, and materials.
Investing in the S&P 500
There are lots of options for investing in the S&P 500 index. The easiest might be buying an S&P 500 index fund, which is investing just as the index is constructed. When an investor buys an S&P 500 index fund, they’re buying the 500+ companies tracked by the index.
There are two types of funds, each constructed somewhat differently: mutual funds and exchange-traded funds, or ETFs. Which an investor decides to use may depend on context.
While the two types of funds are different in construction, both an S&P 500 index mutual fund and an S&P 500 index ETF will accomplish largely the same thing.
For example, someone may have a 401(k) plan that provides them a list of mutual fund options, so they use mutual funds. Investors who open an account at a bank or on a trading platform of their choosing can invest in whichever is available.
At SoFi Invest, investors can buy an S&P 500 index ETF, effectively investing them in the S&P 500 index.
Index investing is easy, affordable, and a strategy that adheres to many popular tenets of investment theory: Index funds can offer a diversified strategy where investors focus less on timing the market or picking the right stocks, and more on focusing on consistent long-term returns.
Investors who would like to take a more active role in building an investment portfolio could consider buying individual stocks, which can also be done using SoFi Active Investing. Instead of buying the whole index, investors can pick and choose their favorite holdings. Alternatively, investors could consider building a portfolio with a mix of both index funds and stocks.
Investors who would like a bit more help to get started might want to consider an automated investing service, like SoFi Automated Investing. This diversified strategy—using index funds—is adjusted according to an investor’s personal goals and appetite for risk.
New investors will likely want to be mindful of the fees associated with buying funds and stocks, as any fees will come out of an investor’s bottom line. SoFi Invest offers free trades on all ETFs and stocks, and investors can get started with as little as $1.
The S&P 500 index can be an investor’s best friend in both understanding the U.S. stock market and investing within it.
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