The Standard and Poor’s (S&P) 500 index is a commonly used stock market index. The index tracks the stock price performance of 500 companies with a market capitalization of over $10 billion.
The parent company of the S&P 500 index is S&P Global, Inc. (formerly Standard & Poor’s). The company is well-known for supplying financial data, credit ratings for investments, and various equity indexes.
This article provides an overview of the S&P 500. When you finish reading this article you’ll have an understanding of:
- When and why the S&P 500 Index came into existence.
- How a company is included in the index and how frequently changes are made to the index.
- How different sectors are weighted in the index and why that matters.
- How to invest in the S&P 500 Index and what are the risks.
A Brief History of the S&P 500 Index
The S&P 500 index originated in 1957. Its purpose was to provide investors with a stock market index that tracked the value of 500 large corporations that were listed on the New York Stock Exchange (the NASDAQ exchange didn’t start trading until 1971).
Throughout its history, the index has held up as a barometer of economic activity. For example, in the 1970s, the index moved steadily lower. This coincided with the stagflation (I.e. stagnant growth coupled with high inflation) that marked that period.
Another example of the index’s ability to accurately depict economic activity occurred during the 2008 financial crisis and subsequent Great Recession. The S&P 500 fell approximately 46%. However, by March 2013, it had recovered most of its losses.
A similar scenario played out in a much more abbreviated fashion during the Covid-19 pandemic. In March 2020, the S&P swiftly dropped approximately 20%. However, by the end of the year the index had already recovered that loss and reached multiple all-time highs in 2021.
An Index, Not an Exchange
Although the S&P 500 is consistently listed alongside the NYSE and NASDAQ as a barometer of stock performance, a key distinction of the S&P 500 is that it’s not an exchange. Rather, it’s an index of stocks that the selection committee designs to reflect every sector of the U.S. economy.
An index is simply a group of common assets (e.g. stocks) that track the performance of a particular market segment. In the case of the S&P 500 the index tracks the performance of 500 corporations that are publicly traded on either the New York Stock Exchange (NYSE) or the NASDAQ.
Why is the S&P 500 Index Important?
Institutional investors rely on the S&P 500 Index (SPX) as a leading indicator for tracking changes in the economy. It is also a recognized way for investors to get exposure to a broad cross-section of the U.S. economy. The index was created in 1957 and ever since has shown to consistently outperform other asset classes.
As of August 2022, the combined market cap of all the companies in the S&P 500 index totals over $36 trillion. The total market cap is arrived at by simply totaling the market cap of every individual component of the index.
The S&P 500 index covers all major sectors of U.S. companies, it is the benchmark that most equity managers are measured against. Although every company in the S&P 500 is headquartered in the United States, the companies are international companies with revenue coming in from all over the world. This adds to the diversification of the index.
However, unlike other stock indexes that base their selection of composite companies exclusively on a defined set of rules, the S&P index is actively managed, meaning that the committee has some discretion in the stocks they select. This allows the committee to respond, as needed, to market events.
What Are the Requirements for a Company to be Listed on the S&P 500?
To qualify for inclusion in the S&P 500’s index, companies must meet the following criteria. This list is current as of March 2022:
- Must have a market capitalization (market cap) of at least $14.6 billion
- Must have liquidity defined as trading the value of that market cap on an annual basis
- Must have traded at least 250,000 shares in each of the previous six months
- Must have a public float with at least 10% of its shares outstanding
- The stock has been publicly trading for at least one year
- The sum of the company’s trailing four quarters’ earnings must be positive, and it must be profitable in its most recent quarter
Many of the companies in the index have little problem meeting these criteria. However, others struggle and the S&P Dow Jones Indices, the committee that decides which companies are in or out of the index, are not bashful about removing underperformers.
How Frequently Do S&P 500 Stocks Change?
The S&P Dow Jones Indices rebalances the index quarterly. This takes place on the third Friday in March, June, September, and December. The rebalancing factors in the stock’s weighting (I.e. its market cap) and other factors the committee considers to be relevant.
This is also the time when companies are added and removed from the index. While this doesn’t occur too often, the average turnover of the index has been about 25 stocks per year with the highest number of stocks changing in one year being 60.
However, there are times when a stock is added or delisted within a quarter. Some reasons for this include:
- The company has been taken over or merged with another company
- The company has declared bankruptcy
- A company has demerged with a company or spun off one of its underlying businesses
- The company has a change in domicile (only U.S. companies are included in the index)
When a company is delisted, the committee will typically add a company at or near the time the company is removed.
How is the S&P 500 Index Weighted by Sector?
As you would expect, the S&P 500 has components from every market sector. Within each sector there are multiple industries and within those industries there are even more specific sub-sectors. The following list is accurate as of August 2022.
- Communication Services - This sector includes industries such as: diversified telecommunication services; wireless telecommunication services; entertainment; media; and interactive media & services. This carries approximately 11% of the index’s weighting.
- Consumer Discretionary - The consumer discretionary sector includes industries such as: automobile components; automobiles; distributors; diversified consumer services; hotels, restaurants & leisure; household durables; leisure products; multiline retail; specialty retail; textile, apparel & luxury goods; and internet and direct marketing. This sector also makes up approximately 11% of the index’s weighting.
- Consumer Staples – The consumer staples sector includes industries such as: beverages; food & staples retailing; food products; household products; personal products; and tobacco. This sector makes up approximately 7% of the index’s weighting.
- Energy – This sector includes industries such as: energy equipment & services; oil, gas & consumable fuels. It makes up approximately 2.5% of the index.
- Financials – The financials sector includes industries such as: banking; capital markets; consumer finance; diversified financial services; insurance; mortgage real estate investment trusts (REITs); and thrifts & mortgage finance. This sector makes up approximately 10% of the index.
- Health Care – This sector includes industries such as: biotechnology; health care equipment & services; health care providers & services; health care technology; life sciences tools & services; and pharmaceuticals. The health care sector makes up approximately 14.5% of the index.
- Industrials – The industrials sector includes industries such as: aerospace & defense; air freight & logistics; airlines; building products; commercial services & supplies; construction & engineering; electrical equipment; industrial conglomerates; machinery; marine; professional services; road & rail; trading companies & distributors; and transportation infrastructure. This sector makes up approximately 8% of the index.
- Information Technology – The information technology (or tech) sector is the largest sector in the index with about 27% of the weighting. This sector includes industries such as: communications equipment; electronic equipment, instruments & components; IT services; semiconductors & semiconductor equipment; software; and technology hardware, storage & peripherals.
- Materials – The materials sector includes industries such as: chemicals; construction materials; containers & packaging; metals & mining; and paper & forest products. This sector makes up approximately 2.5% of the index.
- Real Estate – The real estate sector includes industries such as: equity real estate investment trusts; and real estate management & development. This sector makes up approximately 2.8% of the index.
- Utilities – This sector includes industries such as: electric utilities; gas utilities; independent power and renewable electricity producers; multi-utilities; and water utilities. The utilities sector makes up approximately 3% of the index.
Why Sector Weighting Matters
As we pointed out above, the S&P 500 is commonly viewed as a measure of market performance. However, the weighting is suggesting where investor dollars are going. That’s why, as of August 2022, a company like Apple is one of the top components of the S&P 500. Nearly every mutual fund and exchange-traded fund (ETF) with exposure to technology will include AAPL stock as one of its holdings.
However, the tech sector does not always outperform the market. For example, in late 2021 and the first half of 2022, energy stocks outperformed technology stocks. Not surprisingly, the S&P dipped into bear market territory. However, the energy components of the index performed quite well.
Likewise, the sectors of the index can be affected by monetary policy. For example, rising interest rates are a good sign for financials. However, falling interest rates may be better for growth stocks as the cost of borrowing eases.
How to Invest in the S&P 500 Index
As noted above the S&P 500 is an index not an exchange. As such, there are several ways to invest in funds that approximate the performance of the index.
A common strategy is to own shares in an exchange-traded fund (ETF). Such as the SPDR S&P 500 ETF Trust (NYSEARCA:SPY) commonly referred to as the SPY. As mentioned above, investors will frequently choose to invest in the SPY because the S&P 500 is widely seen as a reliable benchmark that captures the depth and breadth of the economy.
What Are the Risks of Investing in S&P 500 Stocks?
Because the S&P 500 index is a barometer of the overall economy, the stocks that make up the index carry the same risk as many other stocks. And since many investors want to select their own stocks, their choice of stocks matters a great deal.
For example, if an investor owns Apple (NASDAQ:AAPL) which is currently the S&P 500 Index’s largest component, they are likely to have better performance than if they own Meta Platforms (NASDAQ:META) which was one of the top 10 components of the index as of March 31, 2022.
That’s why ETFs are so popular. By owning a basket of S&P 500 stocks much of the risk is smoothed out. As a result, investors can expect a fund such as the SPY to closely approximate the performance of the index itself.
