Are you wondering how to invest in S&P 500 companies? The S&P 500 Index comprises 505 common stocks issued by 500 companies traded on American stock exchanges. Indeed, some companies (I.e., Alphabet) have more than one class of shares, and as a result, more than one class gets included.
The S&P 500 index comprises 500 companies traded in the US. And together, total about 80% of equity by market cap. As of December 31, 2022, the S&P 500 market capitalization was 33.8 Trillion US Dollars.
When I started investing, it was around 1999: the dawn of the tech bubble. I remember buying companies like Netscape and Yahoo, all without knowing why. What I do remember is that the share values increased steadily. And they did, until 2001. However, I had no idea what I was doing and took my profits. I didn’t touch the stock market again until 2004, when I got introduced to an S&P 500 ETF. Since then, I’ve invested in S&P 500 companies, index ETF’s, options, and futures.
This article covers (just about) everything to know about investing in the Standard and Poor’s 500 Index. Namely, what companies are in it, how they get added, why it’s a popular investment, and how you can invest in it today.
What is the S&P 500
The S&P 500 index includes some of the largest 500 worldwide companies that trade on American stock exchanges. When you invest in the S&P 500, you’re investing a proportion of your money in all these 500 companies. Putting it differently, you’re buying a tiny portion in each of the companies in the index. Doing so gives you diversification and decreases portfolio risk. However, it comes at a cost. You probably won’t get stratospheric returns as you might have read about with the recent meme stocks craze.
What Does it Take to Get Included in the S&P 500?
Suppose a company wants to get included in the S&P 500 index. In that case, they should be a US company, have a market capitalization of at least USD 9.8 billion, be highly liquid, have a public float of at least 10% of its shares outstanding. Its most recent quarter’s earnings and the sum of its trailing four consecutive quarters’ earnings must be positive.
Related read: Best International ETF – Our Top 10 to Consider
The Top 10 Companies in the S&P 500 Index
- Alphabet (Class A)
- Berkshire Hathaway
- Alphabet (Class C)
For the rest of the companies on the S&P 500 Index, click here.
Ways to Invest In S&P 500 Companies
Investors looking to buy into the S&P 500 often use low-cost index funds. Indeed, when one looks at the total assets under management, it’s no surprise that it’s a ubiquitous way to gain exposure to the index. However, index funds aren’t the only way. In this section, I’ll explain how index funds work and how to buy them. Also, I’ll explain the other ways you can invest in the S&P 500.
S&P 500 Index Funds
The most common way to invest in the S&P 500 is through a low-cost index fund. Index funds offer investors:
- Diversification – Choosing these investment funds allows you to participate in the ownership of 500 different companies. Doing so lowers your risks through diversification. If one or two companies perform poorly, your portfolio won’t get as affected as if you owned the companies on their own.
- Single trade – Buying an index fund allows investors to own a small portion of the 500 companies that comprise the S&P 500. Investors need only to make one trade to get complete exposure to the index. For example, say your brokerage charges $8.99 to place a trade. To own a portion of all the companies on the S&P 500, you’d only need to make one trade for an S&P 500 ETF or mutual fund. However, if you bought all 500 companies, that cost could skyrocket to 500 & $8.99 ($4,495).
- Reliable performance – Since the beginning, the S&P 500 has returned about 10% annually before dividends. On top of that, you’ll get a quarterly dividend, which is currently about 1.4%.
- Low cost – Costs (expense ratio) are an advantage that makes many people love these index funds is their low cost due to passive management. While a portfolio manager might charge 1% for their services, an index fund might carry
- Buying S&P 500 index funds is easier than purchasing individual stocks. An investor would have to buy shares in each of the 500 separate companies to get similar performance. Indeed, trading commissions and time would make it impractical.
S&P 500 Index funds cost little to manage due to passive management. Since fund managers are not spending their time and money researching stocks to buy or sell, costs will be lower than actively managed funds. The expenses saved get passed to the investor.
For this reason, investors should know that lower expense ratios mean more money will work for them. And, it has the potential to outperform actively managed funds.
Diversification is an advantage where investors can capture returns from a large stock market segment through one index fund. Indeed, it’s because S&P 500 index funds will have 500 companies worth of holdings.
While there are a few cons to investing in S&P 500 index funds. Here are few things to consider:
S&P 500 index funds track the performance of the index. Therefore, you could make more (or less) by investing in individual stocks.
Tracking error refers to the difference between the index fund’s performance and the index itself. For example, if the S&P500 index advanced 20%, and the index fund went up 19.5%, there’d be a tracking error of 0.5%. Consider an index fund with a low expense ratio to keep tracking errors to a minimum.
Steps To Start Investing In The S&P 500
You’ll need a brokerage account to start investing in the S&P 500. Chances are, your bank has a brokerage account that you can set up. Otherwise, you can use brokerages like Robinhood or Vanguard.
The account you’ll open will be either a cash or margin (taxable) account, a registered account such as a Roth IRA or a traditional IRA, or an employer-sponsored 401(k) account.
These brokerages will allow you to trade stocks, ETFs, and mutual funds. The main differences between these companies are in the service and the fees.
As usual, always consult with a financial or investment advisor for investment advice.
Choose Either S&P 500 Index Mutual Funds or ETFs
Once you’ve opened a trading account, the next step is to decide what you want to trade: Mutual Funds or ETFs. Both these options are similar in that they track the same index. However, there are some subtle differences.
S&P 500 Index Mutual Funds are instruments you buy and intend to hold for a long time. They also trade once a day after the market has closed. Some mutual funds have a minimum length of time money you can invest.
If you opt to withdraw earlier than planned, you could get a penalty. But the advantage of mutual funds is that the expense ratio is often lower than an ETF.
S&P 500 Index ETFs, on the other hand, differ from mutual funds. You can buy and sell them like stocks. However, they don’t have a constant price and keep changing throughout the day depending on trading activity.
Unlike bespoke ETFs such as international ETFs, Index ETFs often come with low management fees. For example, the Vanguard S&P 500 index fund (VOO) has a 0.03% management fee – or $30/yr to manage $10,000. Moreover, some discount brokerages will allow you to trade ETFs for free. ETFs’ benefit is that they don’t have a minimum time to hold them or a minimum amount to purchase apart from the single share price. Some brokerage now allows fractional share purchases, thus allowing investors to buy into the S&P 500 for as little as $1.
Choose Your Favorite S&P 500 Fund
In this section, you’ll find three of the most popular S&P 500 Index ETFs and three of the most popular S&P 500 Index Mutual funds.
The following are some of the most commonly traded S&P 500 Index ETFs on the market, in order of their expense ratio (Cost). ETFs get traded in a brokerage account between the buyer and the ETF seller on a secondary market. The price of the sale or the purchase gets crystallized at the time of the transaction.
Vanguard S&P 500 ETF (VOO)
- Started: 09/07/2010
- 90-Day Average Volume: 3M/day
- Expense ratio (Cost): 0.03%
ISHARES S&P500 (IVV)
- Started: 05/15/2000
- 90-Day Average Volume: 4M/day
- Expense ratio (Cost): 0.03%
SPDR S&P 500 (SPY)
- Started: 01/22/1993
- 90-Day Average Volume: 70M/day
- Expense Ratio: 0.09%
The following are some of the most common S&P 500 Index mutual funds. Mutual funds are transacted between the buyer and the mutual fund company and settle after the markets close. In other words, you may pay more or less than expected when buying. Conversely, you may receive more or less than expected when selling.
Fidelity® 500 Index Fund (FXAIX)
- Started: 02/17/1988
- Expense Ratio of just 0.015%
- Minimum Investment: $0
Schwab S&P 500 Index Fund (SWPPX)
- Started: 5/19/1997
- Expense Ratio (Cost): 0.02%
- Minimum Investment: $2,500
Vanguard 500 Index Fund Admiral Shares (VFIAX)
- Started: 8/31/1976
- Expense Ratio: 0.04%
- Minimum Investment: $3,000
S&P 500 Index ETF vs. Mutual Fund
The ETF’s advantage is that you can buy and sell them at the current price during regular trading hours. And, when you buy or sell the ETF, you are transacting with another buyer or seller in the secondary markets.
On the other hand, when you buy a mutual fund, you’re transacting directly with the mutual fund company. Also, mutual fund transactions settle after the markets are closed. As a result, the price you expect to pay or receive could be different than what you expect.
When it’s Time to Make the Trade
Once you’ve decided to invest in the S&P 500 and picked out your favorite ETF or Mutual Fund, you can deposit money into your brokerage account. Once the brokerage company deposits your cash, you can start investing by buying your fund with only a few clicks.
Other ways to invest in the S&P 500
While index funds are the most common way to invest in the S&P 500, they aren’t the only way. For example, some investors might want access to markets well beyond regular trading hours. And other investors might want access to leverage beyond what might be available through an ETF.
A futures contract is an agreement to buy or sell something on a specific date, and at a particular price, in the future. Brokerages will need to approve investors first before they can trade futures contracts.
The benefit (and risk) of futures trading amounts to leverage and margin.
When one buys a futures contract, they are purchasing a multiple of the index. And, the brokerage account requires a small cash deposit for the trade.
The Two Primary S&P 500 Futures Contracts
ES (E-mini S&P 500) – Gives investors exposure to 50x the S&P 500. For example, the current level of the S&P 500 is 4198.86. The ES E-mini S&P 500 contract is worth $209,943.
SP (S&P 500 Stock Index) – Much like the ES above, it exposes investors to 250x of the S&P 500. So, taking from today’s value of the S&P 500, one SP contract is currently worth $1,049,715.
And there are no mandated margin minimums to get into the trade. However, as of today, investors will need about 5% to get into either trade.
An option is a contract between a buyer and a seller. It gives the buyer a right, but not an obligation, to buy or sell something to the seller for a specific price before a particular date.
Investors looking to gain exposure to the S&P 500 through options can purchase call options against an ETF or a futures contract. For example, an investor could buy a call option on the SPY with a $420 strike price that expires in two months, for $1,418. If, at expiration, the SPY ETF is trading above $420, the option will expire “In the money,” and the investor may realize a profit. Conversely, the investor loses their money if the ETF is below the strike price at expiration.
Investors can also purchase put options if they feel the market will decrease. Put options work differently than call options in that they are profitable when the price of the ETF (or futures contract) is below the strike price at expiration. Indeed, this isn’t typically used to invest in the S&P 500; it’s more commonly used to insure a portfolio against a downturn.
CFDs, or “Contract for difference,” is a contract between two parties that allows the investor to participate in the difference of the price of the underlying index or equity at expiration. Not all countries allow CFDs. Notably, the United States bans CFD trading.
The Bottom Line
There are numerous ways and benefits to investing in the S&P 500. The index offers investors broad exposure to 500 different companies. The S&P 500 index also (historically) appreciates about 10% a year, plus dividends.
When someone invests in a low-cost S&P 500 index fund, they eliminate the risks of picking individual stocks. For example, if one stock went to zero, the investor would have 499 other companies in the fund. This Investment also allows investors to diversify their portfolio with numerous large companies from different sectors.
People using low-cost index funds to invest in S&P 500 companies is one of the most popular DIY investing methods. Is it for everyone? Portfolio managers often shy away from index funds because they get paid to beat the index. But, the best managers are expensive and hard to come by. So, the choice is up to you!
The article How To Invest In The S&P 500 – Everything You Need to Begin originally appeared on Rick Orford – Invest, Earn More Income & Save Money.
This article originally appeared here and was republished with permission.