Standard and Poor’s 500 (S&P 500)

S&P 500 is a common stock market term you should know. Here’s what it is.

What is the Standard and Poor’s 500 (S&P 500)?

The Standard & Poor’s 500, or S&P 500, is an index made up of 500 top American companies and is an indicator of how the U.S. stock market is performing. Financial experts consider the S&P 500 to be one of the most accurate representations of the market. It is also viewed as a leading indicator of the future performance of the U.S. stock market.

Deeper definition

Although the S&P 500 is made up of large-cap stocks, its performance is considered an accurate reflection of the overall market. This is because the market capitalization of these 500 companies makes up approximately 70 percent of the market.

The S&P 500 is tracked by Standard and Poor’s, a leading publisher of financial research and analysis. The S&P Index Committee determines which companies to place on the index. When selecting companies for the index, the committee considers market size, index, liquidity and industry grouping, among other factors. Each company’s market capitalization must be equal to or greater than $5.3 billion. The company must have a minimum monthly trading volume of 250,000 shares in the six months prior to the evaluation date, and at least 50 percent of the company’s stock must be available to the public.

The value of the S&P 500 continually fluctuates based on the values of the 500 stocks. The S&P 500’s value is calculated by first adding together the market capitalization of all 500 stocks. This is referred to as the index weight. Next, the weight of each company is calculated by dividing the market capitalization of each company by the total index weight. Companies with larger market shares carry more weight on the index. Therefore, their fluctuations have a bigger impact on the index.

There are a couple of ways to invest in the S&P 500. High-net-worth investors can construct their own personal index funds. However, this process requires buying stocks from 500 companies. More commonly, investors buy mutual funds or exchange-traded funds that mimic the S&P 500.

The S&P 500 index is part of the S&P Global 1200 family of indexes. Other members of the S&P Global 1200 family of indexes include the S&P MidCap 400, which measures the performance of stocks based on 400 midsize companies, and the S&P SmallCap 600, which measures stock performance based on 600 small companies.

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Example of the S&P 500

The S&P 500’s average return between its inception in 1928 and 2014 was 10 percent. After adjusting for inflation, the average return was 7 percent. However, this doesn’t tell the whole story, as 40 percent of S&P 500 gains have historically been from dividends. If calculations are made to account for investors reinvesting the dividends, the rate of return increases substantially. It’s also important to note that these rates of return are averages. The time individuals enter and exit the market significantly impacts the S&P 500’s performance. For example, in 2000 the index declined by approximately 50 percent as the dot-com bubble burst. In March 2009 the index rose 20 percent.

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