What is S&P 500?

Fundamentals · Jul 1, 2019

The S and P index was developed by Standard & Poor’s company in the US. This company specializes in financial market analysis and they needed to develop a tool that can represent the current state of the whole American market in just one number. To solve this problem, they’ve decided to combine the biggest 500 American companies according to the market capitalization of their stocks.

Illustration

This indicator has been in use for almost 100 years and it’s widely popular among individual investors, financial managers and other market participants.

What Does S&P 500 Represent?

This simple number represents about 80 percent of the American equity market by capitalization. The number itself is arbitrary and it doesn’t mean anything, the only important thing is where it’ll go in the future. For example, since the start of 2019 to June 2019, the index rose from 2,500 points to 2,900. This is a significant positive market movement which tells us that the American stock market have been doing well since the beginning of this year.

Of course, things aren’t that simple in the real world and such a fast pace of growth may indicate that the market is overheated, which means that people’s expectations are too high and it can lead to the formation of a bubble which is going to bust in the future.

How to Calculate the S&P 500?

This index is calculated by combining weighed values of 505 stocks (500 companies).

A fluctuation of a stock’s price of a big company like Apple or Google would result in a big change in the index (because of their weight and their total market value) while many of smaller companies don’t affect the index in any significant way.

Here is the formula that can be used to calculate the index:

$$ SP = \frac{MC}{ID} $$

Where:

Often, there is no need to manually calculate S&P 500 Index as it’s calculated automatically.

Who’s in the Index?

The S&P 500 includes many old and new American companies representing all of the major industries:

  • Energy
  • Healthcare
  • Industry and Production
  • Finance and Investments
  • IT and Communications
  • Retail and Customer Services
  • Real Estate

All major areas of the US economy are represented in the index.

Companies that are included in the index might be easily excluded if their stock price goes down. 8 new companies were added to the index since the start of 2019, therefore 8 other companies were kicked out of the list. The oldest companies were added to the index in 1964, although a few other firms were there from the beginning.

Does it Represent The Economy?

This indicator shouldn’t be confused with country’s GDP or other macroeconomics indicators.

The S&P 500 index serves as the representation of the current stock market value, but not the economy itself. A company could have a long history and stable income, but its market value may temperately fall due to many reasons.

The stock market often behaves independently from the real economy and investors may like a certain stock just because it’s popular at the moment, but it doesn’t mean that this company is good. Everything tends to grow in the bull market and it’s not so easy to assess the real value of a company.

That being said, the S and P index does tell us some important information about the economy such as people’s market expectations, history, enthusiasm and so on.

How to Invest in the S&P 500?

You can’t buy an index directly because it’s just a formula but there are ways to invest in the index funds with a bank, a brokerage service, or with the help of a financial advisor. Technically, you could even buy all of the stocks included in the index separately in a particular proportion, although you would probably spend a lot of time on rebalancing and a lot of money on transaction fees.

Should I Invest in The Index?

Investing in this index is like betting on the whole American market in general. In good times it’s a smart idea because it provides almost perfect diversification and it’s also a nice option for those who prefer to invest conservatively and passively. For an experienced investor buying the S and P index might not be the best choice because it’s quite possible to perform better than the market average with another strategy. Actually, the whole point of professional stock market investors is to overperform this index.

That being said, the S&P index historically showed an impressive rate of return around 8%, which can be hard to beat even with a smart and aggressive investing approach.

analytics   economics   trading   the united states   market   indicators   investing   index   portfolio

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