Please Welcome to the Stage…the Standard & Poor’s Index!

Sheaff Brock | S&P 500 is a measuring stick of the 500 largest US corporations

Please Welcome to the Stage…the Standard & Poor’s Index!

It’s a measuring stick, a benchmark, a way to discuss our investment markets. But what, exactly, does it DO? The S&P 500 index measures the value of the stock of the country’s 500 largest corporations listed on the New York Stock Exchange or on the Nasdaq Composite. The idea? To provide investors a quick look at the stock market and the economy. And, while many investors first check the Dow Jones Industrial Average, the S&P 500 index is the most popular measure used by the financial media and by professionals in discussing the state of economic affairs.

What is the S&P 500 index NOT? 

An index, it’s important to remember, is not an investment instrument. Unlike a mutual fund, it’s not “managed”; you can’t buy the index in the form of a “basket of stocks”—indexes in general are unmanaged and unavailable for direct investment. What the Standard & Poor’s 500 does represent is a reportable calculation based on prices for a collection of stocks.

Index funds and index-based exchange-traded funds, by contrast, are investments. The goal of those instruments is to mimic as closely as possible the behavior of the index itself. It is impossible to duplicate the exact behavior of the index, and such funds are always either overshooting or undershooting by a tiny bit, Jeff Little points out in

While the Dow Jones Industrial Average is a price-weighted index that gives companies with higher stock prices a higher index weighting, the Standard & Poor’s 500 is a market-capitalization-weighted average. Each of the 500 different companies is given “weight” according to its market capitalization, meaning the number of shares of that company that are outstanding multiplied by the value of each share that day. Large companies, by definition, account for a greater  “weight,” or portion of an index, than small-cap stocks. In fact, the top four holdings of the S&P 500 now account for more than 10% of the entire index! Those holdings include:

  1. Apple (AAPL)
  2. Microsoft (MSFT)
  3. Amazon (AMZN)
  4. Facebook (FB)

What’s more, the top 50 companies in the S&P 500, by market capitalization, account for 50% of the index’s value.

Despite this obvious “flaw” in the weighting of the S&P 500 benchmark (in terms of both company market share and the fact that all four are technology-related), the S&P 500 is widely considered a good gauge of the health of the broader market.

Still, there are disadvantages to using the S&P 500 as a benchmark for individual portfolio performance, as the authors of admit. Many investors are diversified into assets other than stock, such as bonds, precious metals, small-cap or foreign stock, or cash, the values of which are not reflected in the S&P 500, so that using the Standard & Poor’s 500 as a benchmark may be an inaccurate measure of portfolio return for those investors.

One important advantage offered by the S&P 500 that bears mentioning is that the components of the index are updated on a quarterly basis. To be included in the index, a company must:

  • Have a market capitalization in excess of $5.3 billion
  • Be headquartered in the U.S.
  • Have traded for 6–12 months after their initial public offering
  • Be at least 50% publicly owned

S&P 500—the useful statistic that’s actually non-usable:

“The average annualized total return for the S&P 500 Index over the past 90 years is 9.8 percent,” CNBC writes, cautioning that “Equity returns come in waves, not in metered doses.”

There are at least two reasons not to fixate on that 9.8% number.

• Dividends are included in the reported returns of the S&P 500, but, looking only at price returns, CNBC points out, not counting dividends, a gain of 5–10% is actually extremely rare—in the 89 years from 1928 to 2016, only six finished with a gain in that range.

• The reported “returns” on an index are hypothetical, and do not count the transaction costs that an investor would need to pay to buy an actual share in each of the S&P 500 companies.

Please welcome to the stage … the S&P 500 Index. At the same time, please keep in mind that an index is an investment measuring stick, not an actual investment!

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