The S&P 500 is seen as a gauge of the stock market itself - here's how this widely watched stock index works

Changes in the S&P 500 index flash constantly in stock exchanges and online during the trading day. The index is seen as a stand-in for the performance of US equities and the economy overall.

Alexi Rosenfeld / Contributor/Getty Images

The S&P 500 is a broad-based stock market index, consisting of the 500 largest US public companies.
The diversity and size of the companies it tracks make the S&P a proxy for the entire stock market.
You can’t invest in the S&P 500 itself, but you can buy an index fund that duplicates its stocks and performance.
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People often say “The stock market is up,” or “The market is down.” But the stock market is an amorphous thing, encompassing thousands of equities and dozens of stock exchanges. What they actually mean is a particular stock market index, or group of publicly traded companies, is up or down.

And if they’re in the US, odds are that index is the Standard & Poor’s 500, or S&P 500.

Named for the number of companies on its list, the S&P 500 is “a broad-based index that includes the cross-section of economic sectors like information technology, healthcare and consumer discretionary, as well as major companies in the financial, energy, industrial, and consumer durable sectors,” says Solomon Tadesse, who heads North American equity quantitative research at Société Générale.

“As such, the S&P 500 is a good proxy of the US equity market and, by implication, the economy and its near-term trends.”

Understanding the S&P 500 can be important for investors. Here’s everything you need to know about this influential index.

What is the S&P 500?

Developed by Standard & Poor’s (now S&P Global), the S&P 500 launched in 1957. But its status as a proxy for the US equity market was cemented in 1968, when the S&P 500 became one of the indicators used by The Conference Board, the business membership and research organization, to forecast economic trends.

It’s what’s known as a weighted index, meaning companies with a higher market capitalization (the total value of all their stock shares), carry more clout in the calculations, so the overall index correlates more closely to the broader market.

The index’s relative level – or the collective worth of the stock shares within it – is expressed in points. In January 2021, it stood at 3,750. So if the S&P 500 goes up by, say 10% during 2021, it would mean an overall index gain of 375 points.

What is the S&P 500 made up of?

One reason the S&P 500 is so widely quoted is its makeup: the 500 largest public corporations in the US (though it actually contains 505 stocks because some companies issue more than one class of shares). They’re organized across 11 industrial sectors.

Individual companies may rotate in and out. The S&P Global’s U.S. Index Committee re-examines and rebalances the roster at least quarterly, although it can happen anytime in an attempt to ensure “the index continues to provide a representative reflection of the large-cap U.S. equity market,” according to an S&P Global blog.

For a company to qualify for the index, it has to meet these criteria:

Be based in the US (though it can have overseas operations)
Have a market capitalization of at least $9.8 billion
Be highly liquid, with at least 10% of its shares outstanding in the public market
Have positive earnings in the most recent quarter, and in the four previous quarters.

What companies are in the S&P 500?

The S&P 500 is full of familiar names, many of them blue-chip companies with strong performance histories of financial performance. As of December 2020, the 10 largest companies (by market capitalization) in the S&P 500 include:

Apple Inc. (AAPL)
Microsoft (MSFT)
Amazon Inc. (AMZN)
Alphabet Inc. Class A shares (GOOGL)
Alphabet Inc. Class C shares (GOOG)
Facebook Inc. (FB)
Tesla (TSLA)
Berkshire Hathaway (BRK.B)
Visa (V)
Johnson & Johnson (JNJ)

What’s the average return for the S&P 500?

Over the past 10 years, the S&P 500 has posted annualized returns of 11.18%. In 2020, it posted a return of 15.15%.

Since the companies within the index are so diverse, and are collectively worth about 80% of all US stocks’ total value, these performance figures are widely seen as synonymous with the performance of the US stock market overall.

Limitations of the S&P 500

Though seen as widely representative, the S&P 500 isn’t perfect.

The S&P 500 is a weighted index, meaning companies with a higher market cap carry more clout in the calculations. As a result, the index may give “disproportionate weighting to the largest companies,” cautions Leyla Z. Morgillo, a certified financial planner with Madison Financial Planning Group. “Those weightings can then skew the performance of the index, resulting in a handful of stocks driving the overall index performance. You wouldn’t be able to tell that just by looking at the overall performance of the S&P 500, which is why it can be misleading at times.”

Case in point: Just two high-tech companies, Apple and Microsoft, together account for more than 11% of the benchmark. “That can create some anomalies as other, relatively smaller relative companies can get lost in the sauce,” says Dan Veru, chief investment officer at Palisade Capital Management.

Then too, in an increasingly globalized economy and stock market, the S&P 500 only includes US-based companies. That means major (and sometimes market-moving) foreign stocks, like China’s Alibaba Group or Germany’s BioNTech SE, can’t figure in its performance – rendering it less useful as an indicator of economic trends.

Other significant stock indexes

Despite the S&P’ 500s prominence, investors watch other indexes as well. Among the competitors:

Dow Jones Industrial Average: One of the oldest indexes, the Dow tracks 30 leading US companies. Of course, that’s far fewer than the S&P 500 – too few, some financial pros feel. Also, its weighting system, which is based on share price instead of total market cap, may unfairly penalize a company that has a stock split.
Russell Indexes: The Russell 3000 considers 3000 U.S.-headquartered companies, significantly more than the S&P 500. So do two other indexes that are built off the Russell 3000: the large-cap Russell 1000 and the small-cap Russell 2000. Many investment fund managers favor the Russell 3000 and its smaller sisters, though the latter can be more volatile than the S&P 500.
The Wilshire 5000:This index encompasses about 3,800 stocks (despite its name), giving it bragging rights as the broadest stock market index – virtually all the publicly traded corporations based in the US. Though obviously larger than the S&P 500, and so arguably more representative, the Wiltshire also ignores the overseas markets.

The Nasdaq-100: This growth-stock-oriented index includes 100 of the largest domestic and international non-financial companies listed on the Nasdaq stock exchange. The index is attractive because of an emphasis on the technology sector, arguably the most influential, fast-growing industry in the US economy now. But its bandwidth is even narrower than the S&P 500’s and following it could put investors at risk in case of a sector downturn.

How to invest in the S&P 500

You can’t directly invest in the S&P 500 – it’s just a list, not a stock itself. But a variety of publicly traded mutual funds and ETFs (exchange-traded funds) buy securities that track the S&P 500, or a particular group of the companies within it, like high-dividend-paying companies or more growth-oriented companies.

All the leading brokerages and financial services companies offer S&P 500 index funds: firms like Charles Schwab, Fidelity, and Vanguard. So do most online trading platforms and apps, like Robinhood and Stash.

S&P 500 index funds are also popular with robo-advisors like Wealthfront and Betterment, which use computer algorithms to invest and monitor investors’ portfolios.

The financial takeaway

For more than half a century, the S&P 500 has been a bellwether for the performance of the stock market overall. Because it represents the largest publicly traded corporations in the US, its performance is seen as a snapshot of the state of US business, and by extension, the US economy.

But this index does have some shortcomings. Its market-cap weightings may favor some companies, or sectors, over others; the bandwidth doesn’t always reflect the entire domestic stock market; and it excludes companies that aren’t based in the US.

Still, the returns of individual stocks, stock funds, and other assets are all compared against the S&P 500. So it can be a good tool for investors as well – to guide their individual investment choices, get a sense of how their picks are performing, and even to duplicate via S&P 500 index funds.