Investing money is really only an investment when you make a return back on what you spent — so what better place to start than by choosing the biggest and most profitable companies?
Blue-chip companies, or well-established household brand names, are easiest to invest in via the popular index fund known as the Standard and Poor’s 500, or the S&P 500. It tracks the performance of the 500 biggest companies according to market cap.
Index funds have become one of the most popular ways to invest thanks to their cost-effective way to diversify one’s holdings across broad sectors or industries. Buying one share of the S&P 500 index fund equates to buying tiny shares of the top 500 blue-chip companies in the United States with a single transaction.
Let’s take a look at the S&P 500 – and ways to invest in it.
What Is the S&P 500?
The S&P 500 is an index that benchmarks performance for businesses with a large market capitalization. The S&P 500 index is a portfolio made up of around 500 of the largest companies that trade on the U.S. stock exchange. It’s one of the most widely recognized gauges of the U.S. economy.
This index is also weighted, meaning the largest stocks make up a bigger portion of the portfolio. For example, the largest stock in the index right now is Apple, which makes up around 6% of the S&P 500. The smallest stock belongs to News Corporation Class B, which is only .008% of the index. So Apple is about 777 times the weight of the smallest stock – but that doesn’t mean it’s small. News Corporation Class B has a market capitalization, or market value of the company’s equity, of $14.3 billion.
With the S&P 500, you’ll get exposure to these companies as well as other recognizable names like Coca-Cola, PayPal, Disney, Home Depot, and Netflix.
How Are Stocks Chosen for the S&P 500?
Not every stock can be included in the S&P 500. To be chosen, a company must be profitable for at least a year. That’s not to say that a company can’t lose money short-term due to operating costs and market conditions, but it must post cumulative profit, meaning profit over a longer-term period.
The company must also have a large market capitalization, which is calculated as the stock price multiplied by the number of outstanding shares of stock — and over 50% of that stock has to be held by the public, meaning individual investors like you and me.
“Companies need to be public, very liquid, and have shares outstanding that can be publicly traded. A committee chooses which companies will be included in the combination of 500 or so companies included in the index,” explains Jalife.
Finally, companies must file financial statements for public review with the Securities and Exchange Commission (SEC), be domiciled in the U.S., and of course, be listed on the U.S. stock exchange.
Investing in the S&P 500 Long-Term
Two ways to invest in S&P 500 companies are through mutual funds or ETFs, which are both versions of an index fund. An index fund allows investors to gain exposure to many securities in a single investment.
“An advantage of investing in an S&P 500 index fund is the ability to try to match the performance of the companies included in the S&P 500,” says Tiffany Welka, financial advisor and accredited wealth management advisor at VFG Associates. “You can use a buy-and-hold strategy with no need to actively monitor the stock market. You also get diversification because the index represents all the different sectors within the U.S. stock market. But one disadvantage is that it’s not representative of the global market.”
Jalife adds that you might consider an additional index fund that will give you exposure to smaller or growing companies, because an S&P 500 index fund only focuses on the 500 largest.
The best way to invest in S&P 500 companies is through an index fund, such as a mutual fund or ETF, that aims to match the S&P 500 performance. You might consider investing separately in small cap companies for more diversification.
Some of the biggest index funds in the world are S&P 500 funds. The second largest mutual fund in the world by assets managed is the Fidelity 500 Index Fund (FXAIX), and the largest ETF in the world by the same measure is the iShares Core S&P 500 Fund.
Virtually all of the biggest and most popular S&P 500 index funds are an excellent place for investors who want large market exposure without having to choose or manage individual stocks. Especially if there is a low expense ratio, or fee, for these funds.
Because of their popularity, competition has driven expense ratios for index funds down to nearly zero, making S&P 500 funds an affordable and historically reliable long-term investment. It’s also made it incredibly easy to open an account and start investing, even — and especially for beginner investors.
S&P 500 Annual Returns
Since its inception in 1926, the S&P 500 index’s average annual return has been between 10% and 11%. This includes the period from 1926 and 1957 when it was the S&P 90, comprising only 90 stocks. Since adopting 500 stocks in 1957, the average annual return has historically been around 8%.
But that doesn’t mean it’s always smooth sailing. “There are times when the market will be negative for a period of time,” says Jalife. “But the good times in the market will more than make up for it. Over a long period of time, you should expect a return in the single or double digits.” A buy a hold mentality will get investors through the ebbs and flows of the market.
In 40 of the past 50 years, the S&P 500 index gained value, which is a great track record. The market has sustained its share of dips and losses, but if you have a long horizon of several decades before retirement, the S&P 500 has proven itself to be a profitable and secure investment.
Compounding Interest From Investing in the S&P 500
With any investment, it’s the power of compound interest that does the heavy lifting over time. “Compounding means making money on money you didn’t have before. When you have time working for you, it’s going to really make a difference over the years,” says Jalife.
Here’s an example. If you’d put just $100 into an S&P 500 fund when it began in 1926, assuming a 10% annual return, you’d have over $855,999 today – that’s without ever adding another single cent to your original $100 investment.
With the same calculations, let’s suppose you start investing with $1,000 in an S&P 500 index fund. You plan to retire in 40 years and want to add $100 a month to your investments. You’d retire with over $604,000. Bump your contributions to $200 a month, and you’ll retire a millionaire.
Those gains are thanks to compound interest working on your behalf. If you have several years to invest, the returns can add up in your favor – in a big way. As with any investment, the most important things are to get started as soon as you can and to consistently invest as often as possible.