When news reports and financial experts talk about what’s happening in the stock market, they most likely refer to the S&P 500. The S&P 500 is the largest stock market index and tracks the share prices of the 500 biggest companies in the US. There are indices for every type of asset class and industry, ranging from the U.S. corporate bond market to future contracts for orange juice or palladium. The Nasdaq Composite Index (IXIC), the Dow Jones Industrial Average, and the Standard and Poor’s 500 Index are the three major stock indexes in the United States.
The S&P 500 is a stock index that tracks the share prices of 500 of the largest public companies. It is also the largest stock index and serves as a proxy for describing the overall health of the stock market or even the US economy. It is also a benchmark for several funds and fund managers. This index represents approximately 80% of the total value of the U.S. stock market.
There are different types of weighted market indices. Some are market-cap weighted, value-weighted and some price-weighted. The S&P 500 is weighted by market capitalization. This means that individual index components are included in proportion to their total market capitalization (shortened as “market cap”), which is calculated by multiplying the number of outstanding shares by the current share price. This means that the movements of the largest stocks in the index have a big impact on the daily movements and long-term performance of the index.
Advantages of market-cap weighted indices:
- Market-cap indexes give investors access to a diverse range of companies, both large and small.
- Large, well-established companies receive a higher weighting, resulting in lower volatility for investors.
Disadvantages of market-cap weighted indices:
- As a company’s stock price rises, it may gain a disproportionate amount of weight in an index.
- Companies with higher weightings can have an outsized impact on the fund’s performance.
What are the top 10 constituents in the S&P 500? (as of September 3rd, 2021)
As the S&P 500 is weighted by market capitalization, meaning that the largest stocks have a significant impact on the index’s long-term performance as well as its daily price movement. The top ten stocks account for 28.6% of the index’s market value. It is therefore crucial for investors to become acquainted with these ten big components to comprehend what drives the broader market.
S&P 500 and Industry Weighting
Many investors debut in the stock market by simply buying the S&P 500 and holding it, as it provides good stock diversification. The S&P 500 covers 11 different sectors.
Industry breakdown as of 30. September 2021
However, it is heavily weighted towards technology, healthcare, and consumer discretionary stocks. Meanwhile there aren’t as many utilities, real estate companies, or firms involved in producing and selling raw materials.
So why invest in the S&P 500 index?
Investing in the S&P 500 is popular for the following reasons:
- Attractive and effortless returns – one of the main reasons individuals invest in the S&P 500 are the returns of the index. Over time, it has returned about 7% per year between 2005-2020.
- Diversification – another reason for the S&P 500’s popularity among investors is that it provides immediate diversification. Investors can own a diverse range of businesses with a single purchase. For example, one share of an S&P 500 index fund provides ownership in five hundred companies.
- Lower risk – the diversification of index funds makes it less risky than owning a few individual stocks. That doesn’t mean you can’t lose money, but the index will fluctuate less than an individual stock.
- Low maintenance: For individuals who don’t like researching dozens of stocks and delving into each company’s financials, S&P 500 ETFs present a good option because they are hands-off/passive investments. Investors are not required to buy or sell investments and are not required to research the individual stocks within the fund.
As good as it sounds, it also presents disadvantages:
- Market-cap weighting : Due to the S&P 500 being market-cap weighted, companies with higher market capitalization have a bigger influence on the price of the index. For example, price fluctuations of Apple and Microsoft have greater influence on the index compared to companies with lower market caps.
- Narrow focus: Even though most companies receive large parts of their revenues from outside of the US, the S&P 500 does not include stocks of foreign companies. Therefore, it is limited in representing the global financial market. Additionally, it does not include bonds and commodities, which are important determinants of the state of financial markets and economies.
- Lack of downside protection: Investing in an index fund that tracks the S&P 500 is advantageous when the market is performing well, but leaves investors exposed to the downside. This is why buying downside protection and hedging are essential.
- No control over holdings: When an investor purchases an index fund, they have no control over the portfolio’s individual holdings, as these are predefined. Investors may have favorites that they want to own, such as their favorite bank or food company.
Trading the S&P 500 with One Signal
ONE-SIGNAL delivers daily long or short signals using the S&P 500 as its reference index, due to its size, popularity and availability of data. ONE-SIGNAL’s analysis purely relies on sentiment indicators, such as the VIX or the put/call ratio. Since its inception, ONE-SIGNAL has outperformed the benchmark index almost every year. Between 2005 and 2020, the S&P 500 returned on average p.a. 7%, compared to ONE-SIGNAL Xpert with 26.5% on average p.a. and ONE-SIGNAL Xpert returning 40.5% on average p.a.
The S&P 500 is a significant index due to its size and its ecosystem. Buying and holding the S&P 500 is common among beginners in the market, as it has some advantages such as diversification. However, narrow focus and market-cap weighting are some of the downsides investors should be conscious about.
There have been several studies both in favour and against active management. The majority (over 60%) managers perform worse than their comparative benchmarks. This doesn’t change the fact that there are exceptional managers and systems regularly outperforming the market. Index investing has merit for individuals taking a broad economic view. However, there are many reasons it is not always the best route to achieving one’s personal investing goals.