Why Is The S&P 500 America’s Most Watched Stock Index?

In the financial markets, not many stock market benchmarks carry as much weight and significance as the Standard and Poor’s 500 index – an index commonly known by market experts and investors as the S&P 500.

This index represents more than a number for everybody with a certain degree of participation in the market. It is a critical barometer of how the American economy is faring and how companies are performing financially.

When people ask, “What are indexes?” the S&P 500 is one of the most perfect examples. This benchmark tracks the performance of the stocks of the 500 largest publicly traded companies in the United States, covering multiple economic sectors and industries as a result.

Launched in 1957, the S&P 500 has become the most followed equity index in the world, serving as a benchmark for countless investment portfolios, mutual funds, and exchange-traded funds to compare the results of their strategy with the performance of this index during similar periods.

Its appeal lies primarily in the fact that it captures the overall situation of the US stock market as it tracks the performance of a group of listed companies that account for approximately 80% of the market capitalization of all publicly traded businesses.

The methodology used by the S&P 500 to add and remove stocks

For a company to be included in this prestigious benchmark, it must meet stringent criteria as the S&P 500 has a specific methodology to select and incorporate the stocks that make up its value.

The first and most important of these factors is a company’s market capitalization. This valuation results from multiplying the number of publicly available shares – those that the public can buy in the secondary market – by the market price of the asset at a given point.

The selection committee, comprised of economists and market experts, carefully evaluates potential inclusions every quarter to ensure that the index complies with its methodology at all times.

At the moment, the technology, healthcare, financial services, communication services, and consumer discretionary sectors dominate the index in terms of weight. The weight assigned to each stock individually is determined by its market cap.

For example, if Tesla’s market cap accounts for 5% of the total aggregated value of the entire 500 shares that made it to the index, Tesla will account for 5% of the value of the S&P 500 index.

In addition, eligible companies must be based in the United States, have a market capitalization of at least $15.8 billion, have their shares listed in a public exchange, and must have generated positive earnings in the most recent quarter as well as over the most recent four consecutive quarters.

Historical performance and economic significance of the S&P 500

Throughout its history, the S&P 500 has been an exceptional indicator of economic trends and corporate performance.

The economic boom that came after World War II, the technological revolution of the late 20th century, and the digital transformation that occurred during the 21st century were all significant to the US economy and the S&P 500 captured most of the gains that were produced by these major catalysts.

According to Business Insider, the index has generated a compounded average growth rate (CAGR) of 10.5% in the past 50 years assuming that all dividends were reinvested. For analysts, this makes the benchmark one of the best alternatives in the market for passive investing.

Although its short-term performance may fluctuate wildly, history shows that the American economy has had a remarkable long-term performance and the S&P 500 has managed to capture most of the upside and gains that corporations have produced over long periods.

ETFs are the most efficient way to invest in the S&P 500

Investors nowadays have a wide range of alternatives to invest in the S&P 500. However, the most popular ones are exchange-traded funds (ETF). These investment vehicles are managed by top-tier financial companies that seek to create a portfolio that is almost identical to the composition of the index at all times.

Since the companies that make up the index don’t change frequently, ETF managers are allowed to charge relatively small fees in exchange for their services. Some ETF providers like Vanguard and BlackRock currently offer ETFs whose performance replicates that of the S&P 500 with annual fees of as low as 0.03%.

These index funds provide immediate diversification and reduce exposure to individual stocks that can add unwanted volatility to an investor’s stock portfolio while still providing ample exposure to the gains produced by the American stock market as a whole.

More sophisticated investors might opt to engage in tactical approaches, such as sector rotation or using the index as a benchmark for active management strategies.

Meanwhile, investment professionals use derivatives linked to the S&P 500 like futures and options for hedging or speculative purposes. This highlights this benchmark’s versatility and its ability to offer a wide range of practical uses beyond simple stock ownership.

Despite the passage of time, the index’s simple approach, which consists of maintaining only the 500 most valuable companies in its portfolio at all times, has helped it stay on top of market trends as businesses that are performing positively during a certain period like tech, oil and gas, and communication services, make it to the top of the index’s list easily and without the need to incorporate subjective opinions to the methodology.