The S&P500 index is one of the main and most popular stock barometers of the American market. It can be used to objectively judge what dynamics are developing in the market as a whole, whether the majority of American stocks are declining or vice versa, the market as a whole is growing. This is the main function of the stock index - to demonstrate the overall dynamics of the entire market at once. Moreover, according to the dynamics of the index, which includes almost all sectors of the country's economy, it is possible to judge the overall economic growth and development of the country's economy.
The beginning of the calculation of the S&P500 index was laid back in 1957, when the analytical agency Standard and Poor's for the first time began to maintain lists for stocks that formed the basis of the index. From the same period, the official calculation and publication of the index as an exchange barometer of the American market begins.
The main ideology of creating the S&P500 index was to make a broad market index that covers all key sectors of the economy and represents them as representatively as possible by the best and largest companies. At that time, the Dow Jones Industrial Average Index was the most popular, but it reflected only the dynamics of the largest companies in the industrial sector, there were separate sectoral indices, but there was no large-scale broad market index for the largest companies in the country.
The S&P500 index is the estimated value of a virtual basket of shares of the 500 largest American companies from various sectors of the economy. These are the largest companies by capitalization. The capitalization of all companies included in the S&P500 index, which is essentially the capitalization of the index itself, exceeds $23.16 trillion. This is about 70% of the capitalization of the entire US stock market.
However, at the moment, due to the rapid development of financial markets, stock indexes are something more than just market barometers. First of all, this concerns the S&P500 stock index, and in order to understand what the stock index really is now, we will consider with you a few key points about the S&P500 index:
- Characteristics of the S&P500 index
- Types of the S&P500 index
- The composition of the S&P500 index
- Structure of the S&P500 index
- Calculation of the S&P500 index
- Rebalancing the S&P500 index
- How to invest in the S&P500 index
- Conclusion
Characteristics of the S&P500 index
As already mentioned, the S&P500 index includes the TOP 500 largest companies by capitalization from various sectors of the economy. But in fact, at the moment the index includes 505 companies and the index is not a static basket of stocks. Its composition and structure are regularly reviewed, companies can be excluded from the index, new ones are added, the weight of a particular company changes. The S&P500 index has quarterly rebalances in March, June, September and December.
Read more: How to invest in stocks and what you need to know
The index is calculated using the weighted average method, and the free-float of companies acts as a weighting factor in the index, that is, the share of their shares in free circulation.
The S&P500 index is calculated in several currencies on various exchange platforms. So, in addition to US dollars, the index is also calculated in Australian and Canadian dollars, in Hong Kong dollars, francs, euros, pounds, yen, Singapore dollars, as well as in Brazilian reals and Mexican pesos.
Types of the S&P 500 index
There are also as many as three forms of calculating the S&P500 index. The main index is calculated exclusively based on the price values of the shares included in it, this is an index with the stock ticker SPX, but there are also other calculation options taking into account the capitalization of the dividends of the companies included in the index (ticker SPXT) and the net price and dividend yield of the index, net of taxes (ticker SPTR500N).
For clarity of comparison, we can see what kind of profitability all three types of index calculation showed every year since 2008. Total returns is the total return of the index, the price increase plus the company's dividends. Price returns is only the return due to price growth and Net total returns is the total return of the index, both price and dividend, net of taxes.
The composition of the S&P500 index
As already noted, the S&P500 index includes the largest companies by market capitalization, but in the index itself they are still "weighted" by the free-float indicator. Thus, the largest share in the weight of the index is not necessarily occupied by the company No. 1 in terms of market capitalization.
At the moment, the company that has the largest weight in the S&P 500 index is Apple (AAPL). The weight of the Epl in the index structure is slightly more than 4%. In general, the first TOP ten companies of the index make up 21.2% of the weight of the entire index.
The list of the largest companies, in terms of weight in the index, is as follows:
The first places are occupied by Apple (AAPL), Microsoft (MSFT) and Amazon (AMZN), and the world-famous company Johnson and Johnson (JNJ) closes the top ten.
Structure of the S&P500 index
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In terms of the composition of the index, the S&P500 index represents all the leading sectors of the US economy:
The largest sector in the index is the information technology sector, due to such giants in the index as Google (GOOGL), Apple (AAPL) and Microsoft (MSFT). The second largest sector is the healthcare sector and the third is the financial sector. The lowest weight in the index is occupied by the telecommunications sector, the metallurgy and mining sector, as well as the real estate sector.
Calculation of the S&P500 index
Below we will look at the basic principles of calculating the index. As we have already noted, the S&P500 index differs from many other indices in that the weighting factor for calculating the index is not just the market capitalization of the company, but the capitalization of the free-float, that is, the share of shares that is in free circulation.
The free-float indicator for companies can change quite often, therefore, in order to accurately follow the calculation principles, the index needs periodic rebalancing, which, according to the plan, take place once a quarter.
In addition, there are separate criteria by which companies, in principle, get into the index, and if they no longer meet these criteria, they are excluded and new ones come to replace them.
Rebalancing the S&P500 index
The company itself, the index operator S&P Dow Jones Indices in its monthly monitoring report on the index defines the following criteria for entering the S&P500 index:criteria for entering the S&P500 index
- All companies in the index must be registered in the United States.
- The company's market capitalization should be at least $6.1 billion.
- The number of issued shares in free circulation of the company must be at least 50%.
- Companies included in the index must be successful and profitable. In particular, a mandatory criterion is that the company must have a profit from operating activities over the past 4 quarters.
- The index includes only liquid ordinary shares of the company, for which there are high trading turnover and which have a sufficient market trading history.
When a company is included in the index, the industry factor is taken into account. In order for the index to be representative and serve not only as a purely exchange barometer, but also reflect the real economic situation, the industries in the index have approximately the same weight as the structure of the real US economy. And this is also guided by the index committee when including new securities in the index.
New companies that meet the criteria for inclusion in the index cannot endlessly replenish it, so many companies that largely cease to meet at least one of the described criteria for inclusion in the index are excluded from it. So for the last more than 75 years of the index's existence, more than 1000 companies have been excluded from it. That is, in fact, during this period, the index made two asset turns, and the average period of a company's stay in the index is about 30 years. However, of course, there are many such companies in the index that have been in it since its formation.
Based on these criteria, we understand that the companies that are part of the S&P500 index are among the best companies according to key criteria for investors. This is the scale of the company, its profitability, a high free-float, which in fact means low dependence on manipulation and large shareholders, as well as high liquidity of the company's shares. Thus, we see that the S&P500 index was created with the goals of practical investment application.
As a result, the index is not a static basket of stocks, but in fact, due to the selection criteria, the process of managed, but long-term investment is carried out in it. That is, this index is a kind of fund with low management activity. However, this leads to the fact that the index actually demonstrates very high and, most importantly, stable results in terms of profitability for long periods of time. That is why 85% of all actively managed funds and managers of trust management strategies cannot beat the S&P500 index in terms of profitability for a long period of time, over 5 years. And only 15% manage to do it.
From all this, we can conclude that the S&P500 index itself is an attractive and interesting investment object. Therefore, in the next part of our article, we will look at how you can invest directly in the S&P500 index.
How to invest in the S&P500 index
Since the S&P500 index is a purely settlement basket of securities, in fact, it is impossible to purchase the index itself on the exchange. Knowing the composition and structure of the index, you can duplicate it, but due to the number of securities and weight coefficients, in order to duplicate the S&P500 index, you will need an amount of more than a million dollars. This is certainly not suitable for all investors, and moreover, it will be difficult and very time-consuming work, in a constantly changing market, to form a portfolio of 500 securities and at the same time accurately maintain the share of each paper relative to the entire portfolio.
Therefore, a number of special tools have been created for investing in the index. Most of them allow you to deal with the stock index in the same way as with a stock, you can buy and sell it literally in two clicks in the exchange terminal.
Below we provide a complete list of all available tools for investing in the S&P500 index, and then we will analyze each class of tools separately in detail.
List of available tools for investing in the S&P500 index:
- ETFs for the S&P 500 index
- ETN on the S&P 500 index
- S&P 500 Futures and Options
Next, we will consider each class of tools in more detail.
Read more: What are futures: types, features, advantages and risks
ETFs for the S&P 500 index
An ETF is a traded exchange-traded fund, an ETF is bought on an index, like a regular stock (we wrote more about ETFs in this article). This is the most affordable and most popular way to invest in the index. ETFs on the index can be from different ETF operators and can be of different types. ETFs that pay dividends and clearly repeat the price movements of the index and ETFs that reinvest dividends and essentially repeat the S&P500 index with the ticker SPXT are an index that is calculated taking into account dividends.ETFs for the S&P 500 index
In any case, the main feature of an ETF is that its task is to track the index values as accurately as possible and this is a way of investing that almost directly brings the investor closer to the same way as completely duplicating the index with a basket of securities. Moreover, there is almost a real duplication of the index, since the ETF operator management company physically buys shares in the necessary proportions and constantly monitors and balances the portfolio so that it corresponds to the index value as accurately as possible. And the ETF itself is only a tradable part of a global fund of securities with an index structure. In practice, the discrepancy between the values of the index itself and the ETF of the traded ETF for it is only a few points.
ETFs for the S&P500 index are traded on various major global platforms in America, Europe and Asia. The largest and most famous platform where ETFs are traded is the NYSE Arca section of the New York Stock Exchange. By the way, the most liquid instrument in the world with the highest trading turnover is currently traded there – this is the SPDR SP 500 ETF Trust (ticker SPY).
Read more: What is the New York Stock Exchange (NYSE)
ETN on the S&P 500 index
ETN (Exchange trade notes) – a traded exchange note. This is a very young financial instrument that has not yet received such a wide distribution as an ETF. From an external point of view, if we compare ETFs and ETNs for the S&P500 index, they are almost 100% identical, but by their nature and form of education they are fundamentally different tools.
ETN is a note, which means that it is a debt instrument, similar in nature to bonds. ETN is issued by banks and, in essence, it is a debt obligation of the bank to repay at the end of the note's circulation period an amount equal to or equivalent to the value of the S&P500 index.
From the point of view of investors in the index in the case of ETN, the main thing is to understand the main features of investing in this tool:
- ETNs will 100% accurately repeat the dynamics of the S&P500 index, since it is not based on real assets that require rebalancing and adjustments – this is the bank's debt obligation, which is calculated exactly with the value of the S&P500 index;
- The difference in risks. If an ETF operator leaves the market, then this practically does not carry a significant risk for investors, since any ETF is based on a real basket of securities, which will then be sold and paid out to participants in proportions. Investing in an ETN is taking on the risk of the financial condition of the bank, which may default on an ETN exactly the same as on a bond. At the same time, as a reward, the bank is paid a significantly higher commission for managing the fund than in the case of ETFs.
- ETNs have their own maturity and are redeemed in the same way as a bond.
ETNs are gaining significant popularity in the investment community and are also traded on leading exchange platforms. The main platform where ETNs are traded on the S&P500 index is the Tel Aviv Stock Exchange (TASE).
S&P 500 Futures and Options
These tools also provide an opportunity to access the purchase of the S&P500, but these tools are still used more by speculative players than by investors due to their nature and calculation properties. We can also say that such instruments carry increased risks of investing in the S&P500 in the form of the emerging leverage effect and require special skills from the investor to correctly and safely invest in the index.S&P 500 Futures and Options
Futures and options on the S&P500 index are traded on special exchanges - the Chicago Mercantile Exchange (CME - Chicago Mercantile Exchange) and the Chicago Options Exchange (CBOE - Chicago Board Options Exchange).
Read more: Chicago Mercantile Exchange (CME): history, structure, advantages and features
Conclusion
If it did not seem simple and attractive to invest in indices in general and in particular in the S&P500 index, it is still worth considering that, firstly, this is primarily a very long-term investment, and secondly, despite the rather strict selection criteria, the turnover of assets in indices is always quite low, it is low in particular in the S&P500 index, which means in practice for an investor investing essentially in a wide market, with all the disadvantages, as well as entire industries and individual companies. Along with the best and most top companies, investors are simply forced to invest in less attractive companies in addition. In this regard, at most market phases, it is a point, selective investment in a portfolio of carefully selected securities that is more effective than a continuous purchase of the entire market.
We are supporters, in most cases, of a point-based approach to investing, when it is necessary to form a diversified, but as selective as possible portfolio of securities.