How to Invest in the S&P 500: A Beginner’s Guide
The S&P 500 is an index comprised of 500 U.S. leading companies, and you can invest in it in many different ways.
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The S&P 500 index is one of the most commonly cited stock market benchmarks in the United States and other latitudes as the companies that comprise this popular index are among the largest, most successful, and profitable ventures on the globe.
Moreover, this index has delivered positive returns to investors over a long period, making it a great alternative for those seeking to put their investment portfolios on auto-pilot by buying and holding any of the financial vehicles that are currently available to mirror its performance.
In the following article, we’ll take a closer look at this stock index, what it is, which companies comprise it, how it has performed over time, and how you can invest in it.
What Is the S&P 500?
The S&P 500® is a large-cap US index constructed by S&P Dow Jones Indices — a division of S&P Global. This index is commonly comprised of the 500 (currently 505) largest US-based businesses and it was officially launched in March 1957. Before that, it was comprised of only 90 companies and it was known as the Composite Index.
Since then, the index has become the go-to benchmark to assess the performance of the US stock market as a whole along with the equally popular Dow Jones Industrial Average (DJIA).
The exact weight assigned to each of the companies that comprise the index is estimated based on their market cap. In this regard, the companies with the largest market cap will be assigned the highest weight. This method is known as float-adjusted market cap weighting.
Pro Tip: Investing in an S&P 500 index fund can help investors gain broad exposure to the largest companies in the United States, with minimal work and due diligence.
At the moment, the top 10 constituents of the S&P 500 are:
- Apple (NASDAQ: AAPL)
- Microsoft Corp (NASDAQ: MSFT)
- Amazon Inc. (NASDAQ: AMZN)
- Meta Platforms Inc (NASDAQ: FB)
- Alphabet Inc. A (NASDAQ: GOOGL)
- Alphabet Inc. C (NASDAQ: GOOG)
- Tesla (NASDAQ: TSLA)
- Nvidia Corp (NASDAQ: NVDA)
- Berkshire Hathaway (NYSE: BRK.B)
- JP Morgan Chase & Co (NYSE: JPM)
Meanwhile, the sector with the highest relative weight in the index is information technology (27.9%), followed by health care (13.4%), and consumer discretionary (11.9%). These three sectors account for 53.2% of the index’s total assets.
According to data from S&P Global, a total of approximately $13.5 trillion in assets are currently tracking the performance of the S&P 500 index while the total market capitalization of the companies that comprise it stood at $5.4 trillion by the end of 2020.
How to Invest in the S&P 500?
Now that you know what this index is, you are probably wondering how you can invest in it. In the following section, we’ll provide a step-by-step guide you can follow to open your first position on the S&P 500.
Step 1: Open a Brokerage Account
The first step to enter a long position in the S&P 500 is to open a brokerage account. This account will enable you to buy any of the vehicles that currently track the performance of this popular benchmark.
There are many different providers in the United States and overseas that offer access to these vehicles. Before you open an account, you should make sure that your broker is a regulated entity, preferably from a top-tier jurisdiction like the United States, the United Kingdom, or Australia.
Moreover, to invest in a vehicle that tracks the S&P 500, you must open a self-directed trading account such as the ones offered by TradeStation or Robinhood. In most cases, it would be advantageous to invest in the S&P 500 through a tax-deferred account like a 401(k) or an individual retirement account (IRA).
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Step 2: Choose Between Mutual Funds and ETFs
There are two main vehicles through which you can invest in the S&P 500 index. These are mutual funds and exchange-traded funds (ETFs).
These two vehicles are fairly similar but it is important to note that mutual funds tend to be more expensive as many of them charge load fees and impose lock-up periods for the funds invested.
Moreover, mutual funds are considered less liquid than ETFs as the latter trades as a regular stock that can be exchanged with short notice.
In terms of cost, exchange-traded funds (ETFs) only charge an annual expense ratio (AER), with the cheapest ETFs that currently track the performance of the S&P 500 charging a 0.03% AER.
Even though ETFs are often the best alternative for retail investors, certain tax-deferred accounts like 401(k)s may limit investor’s alternatives to mutual funds.
Step 3: Pick Your Favorite S&P 500 Fund
Based on their amount of assets under management (AUM), the following is a list of the largest exchange-traded funds currently tracking the performance of the S&P 500:
- SPDR S&P 500 ETF Trust (NYSEARCA: SPY) — $391.9 billion
- iShares Core S&P 500 ETF (NYSEARCA: IVV) — $301.5 billion
- Vanguard S&P 500 ETF (NYSEARCA: VOO) — $252.2 billion
Meanwhile, this is a list of the cheapest ETFs currently tracking the index:
- iShares Core S&P 500 ETF (NYSEARCA: IVV) — 0.03% AER.
- Vanguard S&P 500 ETF (NYSEARCA: VOO) — 0.03% AER.
- SPDR Portfolio S&P 500 ETF (NYSEARCA: SPLG) — 0.03% AER
For mutual funds, here’s a selection of the most appealing alternatives:
- Fidelity 500 Index Fund (MUTF: FXAIX) — 0.015% AER / no minimum investment required.
- Vanguard 500 Index Fund Admiral Shares (MUTF: VFIAX) — 0.04% AER / $3,000 minimum investment required.
- State Street S&P 500 Index Fund Class N (MUTF: SVSPX) — 0.16% AER / $10,000 minimum investment.
Pro Tip: Typically, mutual funds are intended to be held for a relatively long period of time, whereas ETFs are bought and sold just like a stock.
Step 4: Place Your Order or Trade
Now that you have a brokerage account and have selected the fund that fits you the best, you can go ahead and buy your first shares.
To do this, you can start by locating a fund or ETF on your trading platform by using the ticker symbol under which it is listed — i.e., SPY or VOO.
After that, you can place an order to buy a certain number of shares or a set amount in the fund. For this, most brokerage firms nowadays allow investors to buy fractional shares of the most popular US-listed ETFs.
These are the three most common types of orders you can use to buy shares of an S&P 500 fund:
- Market orders: The order will be executed using the current listed price of the fund.
- Limit orders: The order will be executed once the limit price is reached.
- Stop-loss orders: These orders are used to limit your losses in case the value of the fund declines significantly. The order will be executed once the stop price is reached.
Step 5: Continue Contributing to Your Investments
The S&P 500 index is considered by many as one of the best passively-managed alternatives to build a diversified stock portfolio. Since the index comprises 500 different businesses in different sectors of the economy, the risk of a pronounced downturn is typically low and occurs only during periods of extremely negative economic conditions or as a result of black-swan events like the COVID-19 pandemic or the 9/11 incident.
According to data from the University of New York, $100 invested in the S&P 500 in 1928 would have turned into $592,868 by the end of 2020, resulting in a compounded annual growth rate of 9.9% including dividends.
With that in mind, one of the best ways to build wealth by investing in the stock market is to make progressive contributions to your investment account that will be immediately invested into a fund tracking the performance of the S&P 500.
You can follow strategies like dollar-cost averaging (DCA) to progressively build your portfolio by averaging the cost basis of your S&P 500 holdings as you will be making purchases at different points in time.
These progressive contributions, along with your previously invested capital, will produce gains over time and you will leverage on the power of compound interest to scale up these gains.
Benefits of Investing in the S&P 500
- Widely diversified stock index comprised of high-quality stocks
- Dozens of low-cost vehicles are available to invest in the index
- Attractive historical returns with relatively low volatility over long holding periods
- Dollar-cost averaging can be implemented even for small accounts through the use of fractional shares.
Downsides of Investing in the S&P 500
- Market timing may affect returns
- The index only includes US-based companies. This makes it highly susceptible to a downturn in the US economy.
Pro Tip: Investing in an S&P 500 index fund can be a wise choice for your portfolio, and that’s one of the reasons why Warren Buffett recommends it to beginner and advanced investors.
FAQs on How to Invest in the S&P 500
The following is a selection of the most frequently asked questions we get on the topic of how to invest in the S&P 500 index.
Should I Invest in the S&P 500?
The S&P 500 has produced attractive gains for investors over time during prolonged holding periods. If the US economy continues to perform positively, as it has in the past century, chances are that the S&P 500 will continue to deliver this kind of positive returns — or better — in the future.
What Is the Best Way to Invest in the S&P 500?
Exchange-traded funds (ETF) are the most attractive vehicle for investing in the S&P 500 index due to their lower expense ratio and high liquidity. Moreover, certain brokers have even waived their fees for their clients if they choose to invest in their in-house S&P 500 funds.
Why Do Investors Like S&P 500 Funds?
The S&P 500 has a positive track record of producing attractive gains for investors while the US economy continues to be the largest and most stable economy in the world. Moreover, the index’s widely diversified basket of stocks makes it a top pick when building any kind of portfolio.
Now that you know what the S&P 500 index is and why it is so attractive to investors, are you ready to buy your first shares in a fund tracking this popular benchmark?
If you are, remember that the performance of your investment may fluctuate during short periods but, in the long-term, these funds are among the best vehicles to build wealth through compound interest.
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Alejandro is a financial writer with 7 years of experience in financial management and financial analysis. He writes technical content about economics, finance, investments, and real estate and has also assisted financial businesses in building their digital marketing strategy. His favorite topics are value investing and financial analysis.
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