How to Invest in the S&P 500

If you’re looking to invest in S&P 500 stocks but don’t have the temperament to sift through and analyze the financial fundamentals of 500 individual companies, an S&P 500 index fund or exchange-traded fund (ETF) can help you gain exposure to all those stocks—without the grueling analysis.

The S&P 500 Index tracks the largest and most dynamic companies in the United States. The index’s constituent stocks are curated by the S&P Index Committee, which selects companies based on a number of factors, including market cap, liquidity, and sector allocation.

In 1976, Vanguard introduced individual investors to the nation’s first mutual fund designed to mimic the S&P 500 Index. Seventeen years later, the first ETF was launched, which similarly tracked the S&P 500 Index. Today, nearly all major brokerages and fund companies offer some type of S&P 500 fund. Investors may access these funds through financial advisors, full-service brokers, or discount brokers.

What Is the S&P 500 Index?

The S&P 500 Index was launched in 1957 as the first U.S. market capitalization-weighted equity index and is widely regarded as the best single gauge of large-cap U.S. equities. The S&P 500 is perhaps the most influential equity index in the world, with trillions of dollars indexed or benchmarked to it. The index consists of 500 leading U.S. companies, although the actual number of companies can vary slightly (there were 505 companies in the index as of Dec. 31, 2021). The combined market value of all the companies included in the S&P 500 Index was $42.37 trillion (as of Dec. 31, 2021), representing approximately 80% of available U.S. market capitalization.

The stocks in the S&P 500 reflect the growth drivers of the U.S. economy to a significant extent. For example, as of Dec. 31, 2021, the top 10 constituents of the S&P 500 by index weight were Apple, Microsoft, Amazon.com, Alphabet Inc A, Tesla, Alphabet Inc C, Meta Platforms, Nvidia, Berkshire Hathaway, and UnitedHealth Group. Apple was the biggest constituent with a 6.9% weight, while the top 10 stocks collectively made up 29.3% of the index. These mega-cap stocks, which dominate the U.S. and global markets, are mostly concentrated in three sectors:

• Information technology, the biggest sector by weight in the S&P 500 index, at 29.2%;
• Consumer discretionary, the third-largest by weight, at 12.5%; and
• Communication services, the fifth-largest at 10.2%.

These three sectors combined account for over 50% of the S&P 500, reflecting the dominance of technology and related sectors in the U.S. economy. Other large sectors in the S&P 500 are healthcare, (13.3%) and financials (10.7%). These five sectors together constitute just over three-fourths of the S&P 500. The other six sectors—industrials, consumer staples, energy, real estate, materials, and utilities—combined make up the remaining 24.3% of the S&P 500 (as of Dec. 31, 2021.)

ETF vs. Mutual Fund

An investor cannot invest directly in an index because an index is simply a measure of the performance of its constituent securities. Index investing can be achieved very efficiently through ETFs and index funds that seek to replicate the performance of specific indexes.

ETFs primarily focus on passive index replication, essentially giving investors access to all securities within the specified index. Thus, an S&P 500 ETF gives an investor exposure to all the stocks in the index. These ETFs generally offer low-cost expense ratios due to minimized active management and trade throughout the day, similar to stocks. Consequently, they are highly liquid, and subject to intraday price fluctuations—just like stocks.

Currently, the largest S&P 500 ETF is State Street Global Advisors’ SPDR S&P 500 ETF (SPY), which had $412 billion in assets under management (as of Jan. 21, 2022). SPY was launched in January 1993 and was the very first ETF listed in the U.S.

S&P 500 index funds tend to have slightly higher fees than ETFs because of higher operating expenses. Furthermore, because a mutual fund has a structure that differs slightly from that of an ETF, investors can only buy it at the day’s closing price, which is based on the fund’s net asset value (NAV).

Index investing pioneer Vanguard’s S&P 500 Index Fund was the first index mutual fund for individual investors. The Vanguard 500 Index Fund Admiral Shares (VFIAX) is the largest index fund, with total assets of $856.1 billion (as of Dec. 31, 2021).

Buying an S&P 500 fund or ETF

Those looking to cheaply invest in S&P 500 ETFs may gain exposure through discount brokers, who offer commission-free trading on all passive ETF products. But keep in mind that some brokers may impose minimum investment requirements. S&P 500 index funds also trade through brokers and discount brokers and may also be accessed directly from the fund companies. Some investors may wish to manage their portfolio through an advisor or a broker, while others might prefer to manage a portfolio of funds that are all housed within a specific mutual fund provider. Investors may also access mutual funds and ETFs through employer 401(k) programs, individual retirement accounts, or robo-advisor platforms.

Why Invest in the S&P 500?

The S&P 500 has been a consistent performer over the long term. In the 10-year period ended Dec. 31, 2021, the S&P 500 had generated annual returns of 16.55%.

Investing in an S&P 500 ETF or fund is a single-ticket solution to get exposure to many of the world’s most dynamic companies in the largest economy. It does away with the need for an investor to spend countless hours analyzing and picking stocks; after all that time and effort, the investment performance may be well below the results that could be obtained merely by investing in an S&P 500 index fund or ETF because it is extremely difficult to beat the market.

Legendary investor Warren Buffett has some sage advice for wannabe stock pickers. Buffett has reiterated on multiple occasions that the average investor is best served by investing in an S&P 500 index fund, and not by trying to pick stocks. At the 2021 Berkshire Hathaway AGM, Buffett hammered home this point by noting that of the 20 largest companies in the world by market capitalization in 1989, not one remains among the top 20 today.

Pros and cons

Some of the benefits of investing in the S&P 500 include:

• Exposure to the world’s most dynamic companies: Investing in the S&P 500 gives an investor exposure to some of the world’s most dynamic companies, such as Apple, Amazon, Google, and Tesla.
• Consistent long-term returns: Although returns in any single year can vary widely over a long-term period of time, the S&P 500 has been a consistent performer.
• Intricate analysis not required: Investing in the S&P 500 through an ETF or index fund means that you do not have to spend hours analyzing and picking stocks in a futile attempt to beat the market.
• Can serve as a core holding: S&P 500 index funds and ETFs are very liquid and trade with tight bid-ask spreads. This makes S&P 500 funds and ETFs ideal as a core holding for most investment portfolios and makes them suitable for advanced strategies like covered calls and hedging.

Drawbacks of investing in the S&P 500 include:

• The index is dominated by large-cap companies: The S&P 500 is dominated by large-cap companies, with its 10 biggest constituents accounting for almost one-third of the index. The median market cap of its constituent stocks was $34 billion as of Dec. 31, 2021. This means that the S&P 500 index does not have any exposure to small-cap and mid-cap stocks that may have the ability to grow much faster than large-cap stocks.
• The index has risks inherent in equity investing: The S&P 500 has risks inherent in equity investing, such as volatility and downside risk. For example, the index lost almost one-third of its value in the space of a few weeks in March 2020. Newer investors may find it difficult to tolerate such volatility.
• Only includes U.S. companies: The S&P 500 only includes U.S. companies and excludes companies in other parts of the world, such as Asia and Europe.

Advancing Beyond a Passive S&P 500 Index Fund

Investors in search of a more advanced approach to S&P 500 fund investing may wish to consider smart beta indexes, which impose lower costs and offer the advantage of fundamental or customized investing. Examples of such funds include the AAM S&P 500 High Dividend Fund (SPDV) and the S&P 500 Equal Weight Index Fund (RSP). Investors may also target certain segments of the S&P 500 Index that offer capital appreciation potential, with funds like the SPDR sector series or dividend-focused funds.

Many fund managers also offer active S&P 500 funds, which focus primarily on S&P 500 names but actively trade names beyond those strictly found in the index. There are also leveraged funds, which offer a simplified hedging approach. Bullish leveraged funds use leverage to multiply the return of the S&P 500 when it performs well. Bearish leveraged funds short the S&P 500 to pull in positive returns when the index falls.