Among the various stock market investment methods, investing in indices has gained popularity among investors due to lower risk and favorable long-term performance. Among the stock market indices in the United States, the S&P 500 stands out as one of the most important and influential. In this article, we acquaint ourselves with this index and explore the methods and benefits of investing in the S&P 500.
What is the S&P 500 Stock Index?
When news related to the US stock market is released and financial analysts discuss the market, there is often mention of the S&P 500 stock index. Essentially, an index follows the price movement of a group of securities. The purpose of creating indices is to examine and display the performance of an industry sector, a market, a segment of an economy, or even an entire national economy.
The S&P 500 index tracks the price changes of the top 500 publicly traded companies in the United States and is one of the most well-known indices used to assess the performance of the US stock market. This index includes the stocks of companies whose total market value exceeds $10 billion. Therefore, this index largely reflects the overall conditions of the stock market and even the economy of the United States.
It is important to note that this index not only serves as a general guide for investors but can also be used as a tool for investment. There are various investment strategies for investing in the S&P 500, such as buying stocks of companies covered by this index and investing in ETFs (Exchange-Traded Funds).
How is the S&P 500 Index Calculated?
The S&P 500 index tracks the price changes of 500 top companies’ stocks. These companies collectively cover about 80% of the total market. Weighted average method is used to calculate this index. In other words, companies with higher market value have a greater impact on the calculations of this index. However, the most important point is that only the freely floating stocks of these companies are considered for calculating the S&P 500. In other words, only stocks that are generally tradable.
Investment Methods in the S&P 500
There are three general approaches to investing in the S&P 500. The first two methods involve investing in ETFs and mutual funds that hold a wide spectrum of companies covered by the S&P 500. The third method involves directly diversifying the investment portfolio by purchasing stocks of S&P 500 companies. It is important to note that investing in the S&P 500 does not require a high level of knowledge about the US stock market and the companies listed in it, unless you want to purchase stocks of specific companies. Let’s delve into these three investment methods in the S&P 500.
Buying Stocks of Companies Covered by the S&P 500 Index
One of the investment methods in the S&P 500 is buying stocks of companies under this index. You can use financial data analysis company Marketbeat to familiarize yourself with these companies. Marketbeat ranks S&P 500 company stocks based on market value on its website. After selecting the companies, you can use brokerage services to access the stock market.
Sure, keep in mind that a share of top American companies can have a very high price in the market. Another solution is buying fractional shares. This method allows purchasing a fraction of a share. For instance, through the Schwab Stock Slices program, it’s possible to buy a fraction of a share of companies in the S&P 500 index. In the table below, you can also see the names of some companies that are part of the S&P 500 index.
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Investing through Mutual Funds:
As mentioned earlier, the S&P 500 is essentially a benchmark for assessing stock market performance. Therefore, direct investment in it is not possible. Also, buying shares of companies within it doesn’t truly count as investing in the index unless you have a substantial capital to buy shares or fractional shares of most companies in this index. A suitable alternative solution is investing in shares or units of mutual funds tracking the S&P 500. These funds purchase shares of all or most of the companies within the S&P 500 index, then divide the fund into tradable shares or units.
There are numerous mutual funds with a diversified portfolio of S&P 500 companies. However, when choosing between these mutual funds, various factors need to be considered.
Some of these factors include:
Minimum investment amount: Each S&P 500 index fund has a specific minimum investment amount, usually varying. Therefore, consider the price per unit of the fund and then decide based on your capital how many units to purchase.
Liquidity: You should buy a fund that allows you to buy and sell its units at any time and at the net asset value of its assets.
Fund performance: S&P 500 index funds may also differ in the amount of shares of companies they hold, and these differences, along with the performance of the fund managers, can affect the fund’s performance. Therefore, examine these factors before purchasing units.
To buy units of these funds, you first need to choose the desired mutual fund. Then, you must open an account with a brokerage that offers units of the selected fund and, finally, based on your capital, buy a certain number of these units.
Investing in S&P 500 through ETFs:
ETFs are also a type of mutual fund but have differences from traditional mutual funds. For example, ETF shares are tradable on public exchanges. Additionally, their share prices fluctuate and behave similarly to company stocks. However, the unit price of mutual funds is determined once a day.
On the other hand, ETFs are purchased as shares, and each unit represents the price of one share. However, mutual funds have a minimum investment amount, which can be determined in dollars or fractional shares. In any case, when the ETF’s investment basket contains shares of companies covered by the S&P 500 index, investing in it means investing in the S&P 500 index.
When buying ETF shares, you should also pay attention to various factors. The first issue is the price of each share of the desired ETF. Also, try to choose an ETF with the lowest expense ratio. Like mutual funds, ETFs also differ in terms of the amount and type of shares, as well as performance and returns. Therefore, by examining its performance history, select the best ETF.
Why Investing in S&P 500 is a Good Idea?
In this section, we set aside the idea of buying shares of one or a few companies in the S&P 500 and focus on exploring the two main methods of investing in the S&P 500: investing in ETFs and S&P 500 index funds. It’s worth noting that the legendary investor, Warren Buffett, always recommends investing in the S&P 500 and himself owns a mutual fund of this kind. Let’s dive into some of the advantages of investing in the S&P 500.
Reducing Risk with S&P 500 Investment:
S&P 500 index funds include shares of many companies covered by the S&P 500 index. Moreover, these companies operate in various backgrounds and cover different industries. This diversity, which is seen in fewer indices, is key to creating a diversified investment basket with minimal possible risk.
In fact, the more diversity there is in your investment portfolio, the lower the risk. For example, if you invest all your capital in shares of one or a few companies in a specific industry like mining, and that company or industry doesn’t perform well, you might incur significant losses. However, the diversity of companies and industries in the S&P 500 mitigates this risk.
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Guaranteed Long-Term Returns:
Investing in the S&P 500 is, in a way, akin to investing in the U.S. economy, which has consistently shown reasonable growth in recent decades. For example, according to research by Crestmont Research analysts, the return on investment in the S&P 500 has been positive on an annual basis over a 20-year period. This means that if you had invested in an ETF or mutual fund based on the S&P 500 over the past 20 years, you would have certainly made a profit.
A Passive Investment Approach:
If you don’t always have the opportunity to sit down at a computer and use various software to analyze the market, examine prices, and determine entry and exit points for trades, investing in the S&P 500 is one of the best options for you. In fact, investing in the S&P 500 requires very little effort. You just need to find a reliable ETF or mutual fund and sit back to review its monthly and annual returns. Additionally, you can increase your investment amount in the fund or ETF of your choice during each period to earn more profits.
What are the Disadvantages of Investing in S&P 500?
Investing in the S&P 500 is a passive investment strategy; this means that if you prefer active approaches, investing in S&P 500 index funds and ETFs might not be the right choice for you. This is because in these methods, the stocks of S&P 500 companies are automatically selected for you, and there’s no option for customization or selecting stocks of specific companies.
For example, you might not be interested in investing in the stocks of some of the subsidiaries of the S&P 500 index. However, the chosen mutual fund or ETF has already purchased shares of those companies. Therefore, if you want the freedom of choice, it’s better to directly purchase full or fractional shares of the companies you’re interested in through brokers and online platforms.
Another major drawback of investing in the S&P 500 is that it’s what we call “can’t beat the market” strategy! In other words, with this investment approach, you can’t outperform the overall market trend. Since you’ve invested in a wide spectrum of well-known market companies, the investment return in this method is average and almost in line with the approximate growth of the entire U.S. stock market.
Let’s review some other disadvantages of this investment approach together:
The S&P 500 index only includes companies with very high capitalization and doesn’t cover companies with medium or low capitalization.
Although the return on investment in the S&P 500 is reasonable and positive in the long term, it’s not immune to market fluctuations, and it can’t be considered as a risk-free method for short-term investing.
The S&P 500 index only includes 500 top American companies and doesn’t cover European companies or companies from other parts of the world.
Mitigate Investment Risk with S&P 500:
If you’re looking for a hassle-free, passive, and minimally risky investment approach in the U.S. stock market, investing in the S&P 500 is one of the best strategies. You can buy units of S&P 500 index mutual funds or shares of S&P 500 ETFs for investment in the S&P 500. Another method is to create an investment basket by purchasing shares of numerous companies under the S&P 500. The first two methods significantly reduce investment risk to a very high extent and guarantee passive income and reasonable long-term returns for you.
Frequently Asked Questions:
What is the minimum investment amount in S&P 500?
For investing in an ETF based on S&P 500 company shares, you need to pay the full price of one share of that ETF, which usually exceeds $100. However, some companies offer fractional shares at lower prices.
Is individual investment in the S&P 500 possible?
Yes, the simplest way is to purchase shares of some important companies covered by this index. Keep in mind that the less diversity of companies, the higher the investment risk, and it requires research and analysis of the performance of stocks and companies of interest.