How To Invest In The S&P 500
In one his annual shareholder meetings, Warren Buffett advised inexperienced investors who have entered the stock market recently to invest in low-cost index funds. He specifically recommended the S&P 500 index as a supreme option for most people. But what is the S&P 500 and how can you invest in it?
What is the S&P 500?
The Standard and Poor’s 500 stock market index, short S&P 500, consists of the shares of 500 large US companies. Contrary to popular belief, these are not the 500 biggest companies but arguably the 500 most important companies. A committee meets each quarter to review which companies belong in the index based on market capitalization, industry and liquidity. A recent prominent addition to the index was Tesla, Inc. Together, the S&P 500 represents around 80% of the total US stock market’s valuation.
The publisher of the S&P 500, Standard and Poor’s, is an American financial data provider and credit rating agency. The company’s roots date back to the 1860s, with the S&P 500 itself being created in 1957. The idea to create a fund mirroring the S&P 500 took another 2 decades to emerge. In 1975, Vanguard founder John Bogle introduced the first-ever index fund, which tracked the S&P 500. Since then, index funds have become widely popular among investors and are key financial instruments for contemporary financial markets.
Investing in the S&P 500 adds broad market exposure to a portfolio. It allows for a diversified strategy and is a bet on the continous growth and success of the overall US economy. Large companies in general are more stable and their shares have deep market liquidity. Thus, their stocks are less volatile and have less risk.
Other important indices tracking the US economy are the Dow Jones Industrial Average and the Nasdaq 100. The Dow Jones Industrial Average groups together the thirty most traded stocks on the New York Stock Exchange and the Nasdaq. The index helps to determine the overall direction of the stock market. Due to the low number of included firms, it is considered by some to be outdated and an inaccurate representation for the overall US stock market development. The Nasdaq 100 is a stock market index comprising the stocks issued by 100 of the largest non-financial companies listed on the Nasdaq stock exchange. The represented stocks are from industrial, technology, retail, telecommunication, biotechnology, health care, transportation, media and service companies.
Read the guide: How Does The Stock Market Work?
S&P 500 index fund performance?
What are the expected returns for an S&P 500 investment? Even though past returns are no guarantee for future returns, the past performance of the S&P 500 index is an indicator of the returns that can be expected with high probability in the future.
- Average Return According to Standard & Poor, over the last 10 years the S&P 500 has generated an average price return of 16.26%. Its worst performance was in 2018 with an annual price return of -6.24%, the best year was 2013 with an annual price return of +29.60%. S&P 500 returns are highly volatile but over the long run strongly positive.
- P/E Ratio The price-to-earning ratio sets the current share price in relation to the earnings-per-share (EPS). In simple terms, the P/E ratio states how many years an investor has to hold a share until he earns his initial investment back. The S&P 500 average P/E ratio over the last 140 years is approximately 16, but has been significantly higher in recent years. During the last 10 years, the ratio ranged between 20 and 35, meaning companies in general have a higher valuation compared to their earnings-per-share.
- Dividend yield measures the cash dividends paid out to shareholders relative to the market value per share. The number states the dividend returns in % an investor gets in relation to the purchasing price of a share. The average S&P 500 dividend yield over the last 140 years has been around 4%, but has continuously decreased over the last several decades to currently 1%-1.5%. One reason for this is the strong increase in stock prices, with which dividend payments could not keep up.
- Outperforming the S&P 500 is the goal of most active asset managers, as the index serves as the benchmark for the overall performance of the US economy. Even though past records prove that the majority of active asset managers didn’t reach this goal, especially after deducting their management fees, some accomplish this goal on a regular basis. A successful way to do so in recent years were investments in large tech companies such as Google, Amazon, Tesla, Apple and Facebook. Other strategies can be venture capital investments (start-ups), booming industries such as semiconductors or pharmaceuticals, newly emerging markets like electric vehicles as well as biotech companies or investments in hedge funds. The most successful investments of last decade have been crypto assets though, which have outperformed all other assets. But caution is advised. Generally, more return comes with more risk, thus the extra yield is not free.
What companies are listed in the S&P 500?
The S&P 500 consists of 500 companies that issue a total of 505 stocks. The reason for the extra 5 stocks is that some companies, such as Berkshire Hathaway, issue multiple classes of shares. The top companies in the index are well known throughout the world. The top 10 constituents in the S&P 500 by index weight are:
- Apple Inc.
- Microsoft Corp
- Amazon.com Inc
- Facebook Inc
- A Alphabet Inc (Google)
- Tesla, Inc
- Nvidia Corp
- Berkshire Hathaway B
- JP Morgan Chase & Co
- Johnson & Johnson
The S&P 500 factsheet by Standard & Poor’s is available on S&P Global. Whilst a you can view a complete list of the 500 companies listed in the index on Wikipedia and various other outlets, there are too many to display here.
Pros & cons of S&P 500 investing
- Steady growth: The S&P 500 lets investors participate in the overall growth of the US economy, which in the long run has generated steady, solid returns.
- Diversification: The S&P 500 includes the biggest companies from different industries and is a valid representation of the overall US economy. This allows for strong diversification, which reduces risk.
- Low costs: The S&P 500 index funds are passive investment vehicles. Due to the absence of active fund managers and low numbers of taxable trades, costs for investors are comparably low.
- No big gains: The S&P 500 will never outperform the market as it is the benchmark for the overall US market performance. As an index including five hundred large players in the US economy, the fund offsets upwards and downwards outliers.
- Lack of flexibility: S&P 500 index funds only allow for investments into the whole index. Poorly performing companies cannot be excluded, outperformers cannot be weighted more a portfolio.
- Crashes and corrections: Investments in the S&P 500 do not protect investors from market crashes and corrections. As the index mirrors the US market, investors are participating in all the market swings.
How to invest in the s&p 500?
Step 1: Define your strategy
Before making an investment, it is important to ask yourself the following questions, as they will help you to find an investment fitting your personality and situation:
- What are your goals for investing?
- What is your timeframe? Is it short-term for a car or long-term for real-estate or retirement?
- How much do you want to invest each month?
- How much risk are you comfortable with?
For short-term goals, low volatility and low risk investments in money market and fixed-income funds are recommended. For long-term goals it is preferable to choose index equity funds such as the S&P 500 with higher risk, higher volatility but also higher expected returns in the long run.
Step 2: Open a brokerage account
S&P 500 index funds can be purchased through various outlets. Most retail investors opt to buy index funds through an online brokerage such as Fidelity, Robinhood and Schwabb. They have simple user interfaces, low fees and provide access to the most common financial instruments such as stocks, bonds, ETFs and funds.
Step 3: Choose between Mutual Funds or ETFs
Funds tracking the S&P 500 performance can be purchased either as mutual funds or ETFs. These two types differ in the way they are traded and priced. ETFs are traded like stocks and thus priced every second according to the market. Mutual funds are only traded and priced once a day after market closure. ETFs have become immensely popular today, thus being the majority of offered S&P 500 trackers, but for long-term investors both options are suitable. Compare fees and conditions before selecting a product.
Step 4: Pick your S&P index fund
Most brokers provide research tools for ETFs and mutual funds including detailed information about each fund. A search for S&P 500 on your broker’s platform lists all available ETF and index funds tracking the S&P 500. Each finding comes with a short description about the fund and its fees. Alternatively, investors can also use tools like the Mutual Fund Observer and Maxfunds when researching potential funds and ETFs. A fee comparison is recommended, as this can save an investor unnecessary expenditures.
Step 5: Monitor your portfolio
Investing in the S&P 500 allows for a hands-off investment approach and daily monitoring is not necessary. Nevertheless, a quarterly portfolio check is advised to stay up to date with the latest market developments and to have a feel for your investment performance.
Depending on your investment goals, it can make sense to set up monthly deposits into your brokerage account, which then can be invested too. This forms a continuous and disciplined investing habit, which is especially important for retirement accounts.
Investing in the S&P 500 is a simple and low-effort way to invest your money. It does neither require much knowledge about the financial markets, nor the overall economy nor individual companies. As such S&P 500 trackers are well suited for investors wanting to participate in the overall long term economic growth without having to do research on their own.
For investors not satisfied with passively participating in the financial markets through ETFs and index funds but wanting to learn more about where the markets are going, what trends are driving them and what topics are worth keeping an eye on, check out RealVision. Hours of videos, in-depth analysis from real experts, crypto education and discussions about the global economy will help you stay up to date in the world of investing and finance.