What is the S&P 500 and Why Should I Care?

If you pay attention to the news, you’ve probably been seeing a lot of headlines like this one “S&P 500 Inches towards Record High,” or “S&P 500 Up for Third Straight Season.” Sounds like a good thing, right? But what is the S&P 500 and why should you as an investor care about it?

The S&P 500 is a collection (also known as an index) of 500 of the most widely held stocks and is designed to be a leading indicator of the US stock market as a whole. To put it in a way that doesn’t sound like a line from your college textbook, the S&P 500 index contains large, well-known companies whose performance has an impact on the market. Movements in the S&P 500 can be used by analysts to predict the future direction of the stock market and the economy as a whole.

The composition of the S&P 500 reflects the various industries in the economy, including Information Technology, Financial, Energy, Industrials, Consumer Discretionary, Materials, Utilities, and Telecom Services. To give you an idea of the types of companies that are included in the S&P 500, the top companies in the S&P 500 in 2015 were Apple, Microsoft, Exxon Mobil, Johnson & Johnson, General Electric, Wells Fargo, Berkshire Hathaway, JP Morgan Chase, Pfizer, and Proctor and Gamble.

The companies included in the index are ones that you have most likely heard of- you may even consume their products in your daily life. To be included in the S&P 500 index, a company must meet several requirements, which often bars new or smaller companies from being included. To be included, a company must have a market cap of at least $5.3 billion, 50% of its stock must be available to the public, the share price must be over $1, and it must have 4 consecutive quarters of positive earnings.

Since the S&P 500 is comprised of stocks that span sectors of the industry, its movements do a fairly accurate job of indicating the state of the US stock market as a whole. Which matters to you as an investor because when people feel good about the market and the economy (when the S&P 500 is up), they tend to invest more in stocks.

Now that you understand what the S&P 500 is, you can understand how keeping an eye on its movements could help you as an investor. One investing strategy, index investing, focuses on matching market returns by investing in funds that mimic certain indices, such as the S&P 500. The strategy is based on the theory that, over the long term, generating returns that match the market’s performance is much more feasible than trying to beat the market by picking individual stocks. You can deploy this investment strategy by investing in ETFs (exchange traded funds) that are designed to mirror the entire S&P 500. Investing in index ETFs is an easy way to diversify your portfolio and it’s much more cost effective that buying 500 individual stocks!

All investing carries risk. Past performance is not indicative of future returns, which may vary. Investments in stocks and ETFs may decline in value, potentially leading to a loss of principal. Online trading has inherent risk due to system response and access times that may be affected by various factors, including but not limited to market conditions and system performance. An investor should understand such facts before trading. The risks associated with investing in international securities, including US-listed ADRs and ETFs that contain non-US securities include, among others, country/political risk relating to the government in the home country; exchange rate risk if the country’s currency is devalued; and inflationary/purchasing power risks if the currency of the home country becomes less valuable as the general level of prices for goods and services rises.

Most inverse ETFs “reset” daily, meaning that these securities are designed to achieve their stated objectives on a daily basis. Their performance over periods longer than one day can differ significantly from the inverse of the performance of their underlying index or benchmark during the same period of time. This effect can be magnified in volatile markets, making it possible that you could suffer significant losses even if the long-term performance of the index showed a gain. While there may be strategies that justify holding these investments longer than a day, buy-and-hold investors with an intermediate or long-term time horizon should carefully consider whether these ETFs are appropriate for their portfolio.

Before investing in an ETF, an investor should consider the investment objectives, risks, charges, and expense of the investment company carefully. The prospectus contains this and other important information about the investment company. You should read the prospectus carefully before investing.