The most reliable indicator of the health of the American stock market is the S&P 500 Index. Many average buy-and-hold investors base their portfolios on funds that track this benchmark index, so learning how to invest in the S&P 500 is an essential skill to develop.
The S&P 500: What Is It?
The S&P 500 is an index of 500 of the biggest public corporations in the United States measured by market capitalization, or the sum of the value of all of their outstanding shares. With a market capitalization of almost $39 trillion, this index accounts for close to 85% of the whole U.S. stock market capitalization.
Due to its scale, knowing the direction and performance of the S&P 500 can offer you a quick indication of how the market is doing as a whole. Additionally, it makes purchasing securities that aim to replicate the S&P 500 a fantastic method to expand your portfolio with a highly diverse group of stocks.
According to Joe Favorito, managing partner at Landmark Wealth Management, “when you purchase the S&P 500, you’re likely to outperform an active portfolio manager buying large-cap stocks 90% of the time.”
Purchasing exchange-traded funds (ETFs) or index funds that follow the S&P 500 is the best way to invest in the index. These funds offer incredibly low expenses and excellent diversification in any instance, albeit there are distinctions between these two strategies that we’ll analyze shortly.
Invest with an index fund in the S&P 500
Index funds that follow the S&P 500 often own most or all of the stocks included in the benchmark index in order to as closely as possible replicate the performance of the index. So that investors like you can get exposure to the fund’s hundreds of constituent investments, they then sell shares of the fund.
There are several S&P 500 index funds available, thus the following guidelines will help you choose the best one for your portfolio:
Ratio of costs. To keep the fund’s asset allocation in line with the benchmark, managers of index funds merely buy and sell stocks. This is known as passive management. There is no requirement for extensive research or trade. As a result, cost ratios—the fees you pay for maintaining your fund—remain extremely low. Because the performance of almost all S&P 500 index funds is quite similar, choosing one with the lowest expense ratio is crucial.
Minimum outlay. Whether you buy index funds for tax-advantaged retirement plans or taxable investing accounts, each has a different investment minimum. Make sure minimum purchase quantities match up with the amount you have to invest as you compare various S&P 500 index funds. After overcoming the first obstacle, you can typically purchase fractional shares for any desired cash amount.
yielding dividends One benefit of investing in the large-cap firms that make up the S&P 500 is the dividends. Because dividends can increase profits even in bearish markets, it is important to examine the dividend yield offered by various S&P 500 index funds.
beginning time. The launch date of an index fund is important to note. Longer-term investments can show you how an index fund survived bull markets and reduced losses during bad markets.
Use an ETF to invest in the S&P 500
Passively managed ETFs, like index funds, seek to match the performance of a market index like the S&P 500. Investors can buy shares from managers after they buy a portfolio of securities to match the holdings of the benchmark index.
Where ETFs vary is as follows: An ETF’s shares trade like stocks and have constantly changing prices. Index fund shares, on the other hand, only trade once each day, right before the markets close. The difference is essentially insignificant for conventional buy-and-hold investors.
It’s interesting to note that the State Street SPDR S&P 500 ETF was the first ETF to be introduced in the United States (SPY). The SPY is still the most traded and largest exchange-traded fund in the world today in terms of assets.
An S&P 500 ETF should be chosen based on several of the important characteristics that you would use to distinguish it from its index fund siblings:
Ratio of costs. S&P 500 ETFs perform similarly to S&P 500 index funds in terms of performance. Since greater costs do not always translate into better returns on the same index, you should always choose the fund with the lowest expense ratio.
Liquidity. Investors who buy and hold securities shouldn’t be overly concerned about ETF liquidity. However, if you’re an active trader in a taxable brokerage account, it’s worthwhile to have a sense of how the liquidity of an ETF can affect your approach. Funds are more liquid if their average trading volume is larger, and less liquid if it is lower.
beginning time. The more economic cycles an ETF has experienced, the older it is. A fund’s capacity to maintain success over the long term can be more confidently predicted the more boom-and-bust market cycles it has endured.
yielding dividends The dividend yield of S&P 500 ETFs, like that of index funds, is the proportion of dividends that the constituent companies of the benchmark index pay out each year per dollar invested. Make sure the dividend yield of the S&P 500 ETF you choose is at least comparable to the finest S&P 500 ETFs, if not higher.
