It’s difficult to discuss investing without mentioning the S&P 500; but how well do you truly understand it? How does it compare to other indices? What are its advantages and shortcomings? In this article, we’ll discuss all that and more so you can make the most of this popular index.

What is the S&P 500?

The S&P 500, or Standard & Poor's 500, is a stock market index that measures the performance of 500 of the largest publicly traded companies in the United States. Introduced by Standard & Poor's (now S&P Global) in 1957, the S&P 500 is widely regarded as one of the best representations of the U.S. stock market and a popular benchmark. You may even hear the S&P 500 used synonymously with the stock market (e.g., as “the market closed up today”). The index includes companies from various sectors, providing a comprehensive snapshot of market health and trends; but just like any metric, it does have its weaknesses.

What comprises the S&P 500?

The S&P 500 is not a static list. Rather, the S&P Index Committee meets quarterly to ensure the index remains a relevant and accurate representation of the market—with size one key consideration but not the only one.

The Committee follows a rigorous and systematic process to include or exclude companies, making decisions based on both quantitative criteria and qualitative judgments. As its goal is to include only the largest and most stable companies in the index, some criteria they must meet are:

Market capitalization

Companies must boast a minimum market capitalization, typically in the billions of dollars, to ensure only large, established organizations are included in the index: providing stability and relevance.

Liquidity

The stock must be highly liquid, meaning actively traded with a robust daily trading volume, as high liquidity ensures it can be bought and sold easily: reflecting accurate market prices and reducing volatility.

U.S. domicile

The company must be based in the United States and traded on a major U.S. exchange (e.g., the New York Stock Exchange).

Public float

At least 50% of the company’s stock must be available to the public (public float), with a higher public float indicating a significant portion of company shares are in the hands of public investors: ensuring adequate market participation.

Financial viability

The company must have positive earnings in the most recent quarter in addition to a positive sum of earnings over the previous four quarters when added together, ensuring only financially healthy companies are included to feed index stability.

Sector representation

As the index aims to represent all 11 sectors of the U.S. economy, the Committee considers sector balance when adding or removing companies.

Companies can also become ineligible and face removal from the S&P 500 for several reasons including:

The company’s market capitalization falls significantly below the minimum threshold
The company’s stock liquidity decreases substantially
Corporate actions (e.g., mergers, acquisitions, or significant restructuring) significantly change the nature of the company, making it no longer representative of its previous form

The company’s in financial distress (e.g., bankruptcy or prolonged negative earnings)

The public float falls below 50%

How the S&P 500 is calculated

The S&P 500 is a market-capitalization-weighted index, which means each company's influence on the index is proportional to its market value: a key element to understand and with implications we’ll discuss in more detail later. Here's a step-by-step breakdown of how the index is calculated:

Market capitalization: The market capitalization of each company is calculated by multiplying its current stock price by the total number of outstanding shares.
Weighting: Each company's weight in the index is determined by dividing its market capitalization by the total market capitalization of all 500 companies.
Index calculation: The index value is then calculated by summing the weighted market capitalizations of all 500 companies and dividing by a divisor, a proprietary figure adjusted by S&P Global to maintain index continuity amidst any stock splits, spinoffs, or other corporate actions.

Historical S&P 500 performance

While calculating performance may sound simple enough, it’s helpful to know there’s more than one way to do so. For example, some calculations include reinvested dividends while others do not. Others adjust for inflation, especially when examining performance over decades. Keeping all this in mind, check out the following historical performance data:

· From 1957 through 2023, the S&P 500’s average annualized return was 10.26%.

· Over the last five years, the S&P has seen average annual returns of 14.87% (including reinvested dividends) for the period ending July 2024.

· Year to date, the index has seen 26.86% returns as of December 13ths market close.

While these figures provide useful information, we must remember that historic returns don’t guarantee future returns. Furthermore, performance is annualized—meaning we’re talking about trends over time rather than static annual numbers—and an index does not include fees.

Weighted index implications

Other things to keep in mind when considering S&P 500 performance are the impact and implications of a weighted index. As of November 2024, the top ten stocks in the S&P 500 accounted for 35.4% of the index—with the top ten holdings accounting for more than a third of index gains in the last five years. The largest companies in the S&P 500 (by weight) included the following as of November 2024:

Nvidia
Apple
Microsoft
Amazon.com
Meta Platforms Inc, Class A
Alphabet Inc. Class A
Tesla
Berkshire Hathaway
Alphabet Inc. Class C
Broadcom

Notice a trend? Perhaps a specific sector? You’re on to something! The heaviest weighted companies in the S&P 500 lean heavily towards tech, perhaps because the current U.S. economy and its future growth are heavily dependent on this industry—so this is an accurate representation. An argument also could (and in fact has) been made that the S&P 500 is too concentrated. While a definitive answer extends beyond the scope of this article and is likely only certain in hindsight, it’s important to keep this in mind when considering the S&P 500. The following example speaks to how this information can impact investment decisions…

Let’s say you’re considering investing in a specific stock, one that’s slightly underperformed the S&P 500 over the last few years. You may consider this fact and conclude the stock is a bad investment, but this perhaps doesn’t reflect the full picture. The stock is in the utilities sector, and when you compare it to other stocks in this industry, you find it outperformed the majority—even though it lagged behind the tech-heavy S&P. This isn’t to say that you should avoid using the S&P 500 as a benchmark in this case, simply that as with any metric, the key to making the most of it is to understand what exactly it’s telling you and what it is not.

The S&P 500 vs other market indices

The S&P 500 is far from the only market index; two other common indices include the Nasdaq Composite (the Nasdaq) and Dow Jones Industrial Average (DJIA), each with its own unique characteristics and role for investors. The better you understand these key differences, similarities, and the specific insights they provide, the more effectively you can utilize them.

The Nasdaq, which includes more than 3,000 stocks listed on the Nasdaq Stock Market and a significant concentration of technology companies, is market-capitalization weighted just like the S&P 500. As a benchmark, it acts as a key indicator for the performance of high-growth (often volatile) stocks, providing insight into tech industry health.

The DJIA (commonly referred to as "the Dow"), meanwhile, consists of 30 large, publicly owned companies that are leaders in their respective industries. Unlike the S&P 500 and Nasdaq, the Dow is price-weighted: meaning stocks with higher prices have a more substantial influence on its movements. The Dow includes well-established companies with robust reputations such as Apple, Microsoft, and Boeing. With only 30 companies, it provides a less comprehensive view of the market compared to the S&P 500 but is often considered an indicator of market sentiment and investor confidence. As one of the oldest indices, the Dow holds historical significance and is frequently referenced in financial news.

Which index is best?

No one index is “better” than another; instead, they serve different purposes as benchmarks. While the S&P 500 provides a more comprehensive view of the overall market, the Nasdaq Composite highlights technology and growth sector performance. The Dow, meanwhile, focuses on major industrial and blue-chip companies. Understanding these differences can help investors choose the appropriate benchmark for their investment strategies and better interpret market trends.

How can you invest in the S&P 500?

The S&P 500 is a list of companies, and you therefore cannot invest directly in the index itself but instead in a fund that tracks the S&P 500. More specifically, you can choose to invest in an index fund—a mutual fund designed to replicate S&P 500 performance—or an exchange-traded fund (ETF), which is similar to an index fund but traded on a stock exchanges and can be bought and sold like an individual stock. For more advanced investors, options and futures on the S&P 500 provide opportunities for hedging and speculation.

While a fund that tracks the S&P 500 should closely mirror index returns, it’s important to keep in mind that performance likely won’t reflect a perfect match (e.g., index performance doesn’t include fees, which are ubiquitous no matter how you invest).

The takeaway

The S&P 500 is a cornerstone of the financial markets. By understanding its composition, significance, and investment avenues, you can utilize this as a valuable tool to make more informed investment decisions.

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What is the S&P 500 and Why is it Important in Investing?