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The S&P 500 Index is the leading barometer for judging the performance of the US stock market. Funds that track this benchmark index provide the cornerstone for the portfolios of many regular buy-and-hold investors—and that makes understanding how to invest in the S&P 500 a key skill to learn.
What Is the S&P 500?
The S&P 500 is a stock market index that tracks the performance of 500 of the largest US public companies by market capitalization—or the total value of all their outstanding shares. With a market cap of roughly $39 trillion, this index represents nearly 85% of the total capitalization of the US stock market.
Because of its sheer size, understanding the direction and performance of the S&P 500 can give you an instant read on how the overall market is performing. It also makes buying securities that seek to emulate the S&P 500 an excellent way to add a very well diversified pool of stocks to your portfolio.
“When you buy the S&P 500, 90% of the time you’re likely to outperform an active portfolio manager picking large-cap stocks,” says Joe Favorito, managing partner at Landmark Wealth Management.
The best way to invest in the S&P 500 is to buy exchange-traded funds (ETFs) or index funds that track the index. There are differences between these two approaches that we’ll examine below, but in either case, these funds offer extremely low costs and superior diversification.
Invest in the S&P 500 with an Index Fund
Index funds that track the S&P 500 typically own most or all of the stocks included in the benchmark index so that they can mimic the performance of the index as closely as possible. They then sell shares of the fund so investors like you can buy exposure to their hundreds of constituent investments.
There are more than a few S&P 500 index funds out there, so here’s the criteria you should use to make sure you pick the right one for your portfolio:
- Expense ratio. Index funds are passively managed, which means that the fund’s managers simply buy and sell stocks to keep the fund’s asset allocation in line with the benchmark. There’s no intensive research or trading that needs to take place. This keeps expense ratios, the fees you pay for the upkeep of your fund, very low. Because nearly all S&P 500 index funds perform very similarly, it’s important to pick a fund with the lowest possible expense ratio.
- Minimum investment. Index funds have different investment minimums, whether you purchase them for taxable investment accounts or tax-advantaged retirement accounts. As you evaluate different S&P 500 index funds, make sure minimum purchase amounts match up with the amount you have to invest. After you hop that initial hurdle, you’ll generally be able to buy fractional shares in whatever dollar value you need to.
- Dividend yield. Dividends are one of the perks of investing in the large-cap companies that make up the S&P 500. Be sure to compare the dividend yield offered by different S&P 500 index funds as dividends can boost returns, even in down markets.
- Inception date. It’s worth paying attention to an index fund’s inception date. Choices with longer histories can help you see how an index fund weathered bull markets and mitigated losses in bear markets.
Invest in the S&P 500 with an ETF
Like index funds, passively managed ETFs aim to duplicate the performance of a market index like the S&P 500. Managers purchase a basket of securities to duplicate the benchmark index’s holdings and then sell shares to investors.
Here’s where ETFs differ: The shares issued by an ETF trade like stocks, with values that fluctuate all day long. Meanwhile, index fund shares only trade once a day, when markets close at the end of the day. For traditional buy-and-hold investors, the difference is pretty trivial.
Related: How To Buy An ETF
Interestingly, the very first ETF launched in the US was an S&P 500 fund, the State Street SPDR S&P 500 ETF (SPY). Today, the SPY remains the biggest exchange-traded fund in the world by assets and the most widely traded ETF.
You should pick an S&P 500 ETF based on many of the key factors that you would use to differentiate their index fund brethren:
- Expense ratio. As with S&P 500 index funds, S&P 500 ETFs all have virtually the same performance. You should always choose the fund with the lowest expense ratio as higher costs do not guarantee better returns on the same index.
- Liquidity. Buy-and-hold investors don’t need to worry too much about ETF liquidity. But if you’re an active investor trading in a taxable brokerage account, it’s worth getting a feel for how an ETF’s liquidity could impact your strategy. Funds with higher average trading volumes are more liquid, and ones with lower trading volumes are less.
- Inception date. The older an ETF, the more economic cycles it has been through. The more cycles of boom and bust markets a fund has experienced, the more confidence you can have about a fund’s ability to sustain performance over the long term.
- Dividend yield. Much like index funds, the dividend yield of S&P 500 ETFs represents the percentage of the component companies of the benchmark index pay out annually in dividends per dollar you invest. When choosing an S&P 500 ETF, you’ll want to make sure its dividend yield is at least aligned with the best S&P 500 ETFs, if not higher.
SoFi Automated Investing
SoFi Automated Investing
Other Considerations for Investing in the S&P 500
Don’t get stuck on holding the S&P 500 as the majority of your portfolio. “There are other areas of the market you need in order to build a diversified portfolio, such as small-caps, mid-caps and international stocks,” says Favorito.
Building that diversified portfolio also means complementing an S&P 500 fund with bond holdings. Check out our listing of the best total market bond index funds to figure out how best to build your two- or three-fund portfolio.
Can You Invest in the S&P 500 with Individual Stocks?
The S&P 500 tracks the performance of almost 500 different companies, from Apple (AAPL) to Xerox (XRX)—and there’s nothing stopping you from buying shares of each and every one of them.
But “if you wanted all of the S&P 500 stocks, it would be very tedious and expensive to purchase them this way,” says Aviva Pinto, managing director at Wealthspire Advisors.
First and foremost, you’d have to shell out a lot of cash to complete a full set of the stocks that make up the S&P 500. To buy one share of just 10 of the largest companies in the S&P 500, for instance, it could cost you more than $8,000.
And that’s without considering that the S&P 500 weights each company based on its market capitalization. This helps it more accurately reflect the impact of a company’s size on the overall market. Accurately duplicating the index weighting would be a management nightmare for an individual investor—and keeping that weighting on track as the market changes day-to-day would be an even bigger headache.
This is why both financial advisors recommend that you buy funds that track the S&P 500 and provide one-stop shopping for those looking to invest in the index.