Scroll through any financially related news story and you’re bound to encounter a report of how the “S&P 500” is doing. You might even exclaim over its rises and dips yourself, despite not completely understanding what it is or the effect it has on you as an investor.
Consider this your go-to primer for everything you need to know about this market indicator and why people pay attention to it.
What Is the S&P 500?
The Standard & Poor’s 500, more commonly known as the S&P 500, is a stock market index that was launched by its eponymous credit agency in 1957. An index is a way to track the overall performance of a financial market by looking at a collection of different investments – in this case, stocks. The role of stock indexes is to provide a big-picture perspective on whether stock prices are generally rising, falling or staying the same at any specific moment in time.
The S&P 500 is comprised of 500 of the largest companies which have their stocks listed on the New York Stock Exchange (NYSE) and the Nasdaq Composite. It includes 11 major sectors:
- Information technology
- Health care
- Financials
- Consumer discretionary
- Communication services
- Industrials
- Consumer staples
- Energy
- Utilities
- Real estate
- Materials
Because these stocks represent such a wide swath of the U.S. economy in a variety of industries, the S&P 500 is considered a reliable gauge for the health of the economy and is generally perceived to better reflect the overall market performance than other stock indexes.
That’s why its performance is watched so avidly throughout the day and why its closing numbers help give people a general sense of the country’s economic direction.
The S&P 500 index is weighted on market capitalization – that is, the share price times the number of shares outstanding – rather than the stock price.
S&P 500 vs. Dow Jones
The Dow Jones Industrial Average (DJIA) is another stock index, like the S&P 500, that tracks representative stocks. However, whereas the S&P 500 is a collection of 500 companies of various sizes, the DJIA is comprised of merely 30 stocks, and these stocks represent the nation’s biggest, best-known companies. Widely regarded as industry leaders, they are also known as “blue chip” companies.
In fact, when the DJIA was created in 1896, its purpose was to track just the 12 biggest companies at the time. Most of them were industrial in nature, thus its name. Today the stocks in the DJIA encompass a much wider number of industries, from retailers like Home Depot to technology companies like Apple. Given the scale of these companies, there is rarely movement in the stocks that form the DJIA.
Unlike the S&P 500, the DJIA is weighted solely by stock price.
S&P 500 vs. Nasdaq
The third well-known index is the Nasdaq Composite Index, which is comprised of all the stocks that trade on the Nasdaq stock exchange. Commonly known as “Nasdaq,” it stands for “National Association of Securities Dealers Automated Quotations,” and the exchange was introduced in 1971 as the first electronic trading system. At the time its goal was to automate securities that weren’t listed on the other two exchanges.
The Nasdaq Composite’s 2,500 stocks include major technology companies like Meta, Alphabet, Apple Inc. and Amazon Inc. In fact, half of its companies are in the technology sector, while the other ones include industries from healthcare to consumer staples. Like the S&P 500, it is weighted based on market capitalization counting only shares that are available to the public.
What Are the Criteria for S&P 500 Companies?
While the 500 companies that comprise the S&P 500 are designed to be representative of the U.S. economy as a whole, they must fulfill a number of criteria in order to be considered:
- Publicly traded
- Based in the United States
- A public float of at least 10%, which translates into how many shares are actually available to be bought and sold by general investors
- A market cap of $14.6 billion or more
- Profitable for the most recent four quarters
- Adequate liquidity as measured by price and volume
How Does the S&P 500 Affect an Investor?
While S&P 500 swings often accurately track the performance of the economy overall given the widespread representation, remember that it is based only on 500 specific stocks.
Therefore, any individual investor might have a different outcome in their own portfolio depending on how diversified it is. For example, if you are most heavily invested in technology or healthcare stocks, those might have different day-to-day performance than the varied bucket that is the S&P 500. And since it only reflects large companies, small- or mid-sized companies might have performed differently on any given day.
The best advice is to avoid becoming too focused on the short-term nuances of the market. By nature, markets fluctuate regularly, and it’s reassuring to realize that historically they have always risen to new heights after any extended downturn. Of the 33 market corrections since 1980, 90% of them saw gains over the following year – averaging about 25%.1
That’s why any investor should take a long-term view of their investments rather than reacting on a day-to-day basis. And the longer your time horizon – that is, the time until you need to tap your accounts in retirement – the better chance you’ll have of the market recovering and surpassing its previous highs. So, while the S&P 500 can give you a window into the overall health of the market, it’s always best to stick to your investment plan for a solid financial future.
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1 Carson Wealth, “Special Market Commentary: What’s Stressing Out Stocks? These Market Inflection Points” May 13, 2022. https://www.carsonwealth.com/insights/market-commentary/special-market-commentary-whats-stressing-out-stocks-these-market-inflection-points/
