How Does The S&p 500 Make Money

The S&P 500 Index

Updated: Nov. 12, 2021, 2:10 p.m.

When it comes to the major U.S. stock indexes, none is more highly regarded as a barometer of the overall stock market's performance and an indicator of how large corporations are performing than the S&P 500 index.

With that in mind, here's what all investors should know about what the S&P 500 index is, how it works, how you can invest in it, and why doing so could be a smart move for you.

What is the S&P 500 index?

From another angle, the S&P 500, as an index, is a statistical measure of the performance of America's 500 largest stocks. In this context, the S&P 500 is a common benchmark against which portfolio performance can be evaluated.

The S&P 500 index is weighted by market capitalization (share price times number of shares outstanding), which means that a company's valuation determines how much influence it has over the index's performance. Each listed company doesn't simply represent 1/500th of the index. Massive companies such as Apple (NASDAQ:AAPL) and Amazon (NASDAQ:AMZN) have a greater impact on the S&P 500 index than relatively smaller companies like Macy's (NYSE:M) and Harley-Davidson (NYSE:HOG).

One key point to know is that although these are 500 large companies, there's a wide range. Several of the largest companies in the index have market caps in excess of $1 trillion, and they are more than 200 times larger than the smallest S&P 500 components, which have market caps between $6 billion and $7 billion.

The value of the S&P 500 index fluctuates continuously throughout the trading day, based on the weighted performance market data of its underlying components.

Which companies are in the S&P 500 index?

The S&P 500 index is composed of 505 stocks issued by 500 different companies. There's a difference in numbers here because a few S&P 500 component companies issue more than one class of stock -- for example, Alphabet Class C (NASDAQ:GOOG) and Alphabet Class A (NASDAQ:GOOGL) stock are both included in the S&P 500 index.

Obviously, it wouldn't be practical to list all of the S&P 500 companies here. But because the S&P 500 is weighted by market cap, its performance is mostly driven by the performances of the stocks of the largest companies.

With that in mind, here's a look at the 10 largest companies of the S&P 500 index as of March 2021. This list and its sequence can, and probably will, change over time.

Apple (NASDAQ:AAPL)
Microsoft (NASDAQ:MSFT)
Amazon (NASDAQ:AMZN)
Facebook (NASDAQ:FB)
Alphabet Class A (NASDAQ:GOOGL)
Alphabet Class C (NASDAQ:GOOG)
Berkshire Hathaway Class B (NYSE:BRK.B)
Tesla (NASDAQ:TSLA)
JPMorgan Chase (NYSE:JPM)
Johnson & Johnson (NYSE:JNJ)

Data source: Dow Jones S&P Indices.

Why use the S&P 500?

You may be wondering why the S&P 500 is considered so useful as a market and economic indicator. Because the S&P 500 consists of a broad basket of stocks without too many small or obscure companies, it contains the companies the most widely owned by individual investors. The 500 companies account for roughly 80% of the overall value of the stock market in the U.S.

S&P 500 versus Dow Jones Industrial Average

The Dow Jones Industrial Average is a price-weighted index, meaning that the companies with the highest stock prices have the most influence on the index regardless of their valuations. The Dow also only lists 30 companies and excludes some of the largest stocks in the market -- for example, Amazon, Alphabet, and Berkshire Hathaway.

Because the Dow is price-weighted, Goldman Sachs (NYSE:GS), with a $238 share price currently, has more than twice as much influence over the Dow's performance as Walmart (NYSE:WMT), despite Goldman's market cap being just one-fourth of Walmart's.

For these reasons, the S&P 500 is considered by most experts to be a better stock market indicator.

Other Major Indexes

Dow Jones

Tracking 30 of the largest blue chip companies on the market.

Nasdaq Composite

Tracking all public companies that trade on the Nasdaq exchange.

Russell 2000

Tracking 2000 companies ranging from small cap to mid cap.

Stock Market Indexes

Explore an overview of the major indexes.

How can you invest in the S&P 500 index?

You may invest in the S&P 500 index by purchasing shares of a mutual fund orexchange-traded fund (ETF) that passively tracks the index. These investment vehicles own all the stocks in the S&P 500 index in proportional weights.

The Vanguard S&P 500 ETF (NYSEMKT:VOO), which trades just like a stock, and the Vanguard 500 Index Fund Admiral Shares (NASDAQMUTFUND:VFIAX) mutual fund are two attractive options. Both have extremely low fees and deliver over time virtually identical performances to the S&P 500 index.

In addition, you can buy S&P 500 futures, which trade on the Chicago Mercantile Exchange. These are essentially buy or sell options that enable hedging or speculating on the index's future value.

Is investing in the S&P 500 right for you?

Legendary stock market investor Warren Buffett has famously said that a low-cost S&P 500 index fund is the best investment that most people can make. It's not difficult to see why. Over long periods, the S&P 500 has delivered annualized total gains of 9% to 10%, and you can easily invest in a passive S&P 500 fund for virtually no cost.

To be clear, if you have the time, knowledge, and desire to properly research stocks and maintain a portfolio, we (and Warren Buffett) feel that it's certainly possible over the long term to achieve superior investment returns relative to the S&P 500. However, not everyone has the time and discipline needed to invest in stocks that way, and newer investors in particular may be better off buying shares in an S&P 500 index fund until they build up their knowledge.

In a nutshell, investing in the S&P 500 is a way to get broad exposure to the profitability of American businesses without too much exposure to any individual company's performance. Over time, the S&P 500 can produce strong returns for your portfolio and with minimal effort on your part.

FAQs

What is the S&P 500?

The S&P 500(also known as the Standard & Poor's 500), a registered trademark of the joint venture S&P Dow Jones Indices, is a stock index that consists of the 500 largest companies in the U.S. It is generally considered the best indicator of how U.S. stocks are performing overall. From another angle, the S&P 500, as an index, is a statistical measure of the performance of America's 500 largest stocks. In this context, the S&P 500 is a common benchmark against which portfolio performance can be evaluated.

What are stock market indexes?

A stock market index shows how investors feel an economy is faring. An index collects data from a variety of companies across industries. Together, that data forms a picture that helps investors compare current price levels with past prices to calculate market performance. Some indexes focus on a smaller subset of the market. For example, the Nasdaq index closely tracks the technology sector. So if you want to know how technology companies are performing, you'd want to look at the Nasdaq stock index.

What is the Nasdaq Composite Index?

The Nasdaq Composite is a stock market index that consists of the stocks that are listed on the Nasdaq stock exchange. To be included in the index:

A stock must be listed exclusively on the Nasdaq market.
The stock must be a common stock of an individual company, so preferred stocks, exchange-traded funds (ETFs), and other types of securities are excluded.
American depositary receipts (ADRs), real estate investment trusts (REITs), and shares of limited partnerships are eligible, however.

That's why there are so many stocks included in the Nasdaq Composite and why the number of stocks in the index changes often. The index is designed to be representative of the entire Nasdaq stock market, not just the largest companies.