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==Investing in the S&P 500 Index== ==Investing in the S&P 500 Index==
-The S&P 500 is one of the best gauges of the US economy, and as such investing in the index is equivalent to casting a wide net on companies who are dependent on the US economy. The retail investors can place bets on the S&P 500 through several ways:+Due to the mandate of the Index committee to keep the index representative of the US economy, the S&P 500 forms one of best gauges of the US economy. Therefore, investing in the index is roughly equivalent to placing bets on the US economy. The retail investors can place bets on the S&P 500 through several ways:
*[[SPDR Trust Series I (SPY)| Standard & Poor's Depository Receipts]], also known as SPDRs or Spiders, are [[exchange-traded funds]] (ETFs) traded in the US and managed by [[State Street]]. The [[SPDR Trust Series I (SPY)]] fund engineers the returns generated by the S&P 500 index through holding the companies in the index in the same proportion as the index. Investors can use other SPDRs such as [[XLE]] (Energy) or [[XLB]] (Basic Industries), to invest in a specific of the US economy. *[[SPDR Trust Series I (SPY)| Standard & Poor's Depository Receipts]], also known as SPDRs or Spiders, are [[exchange-traded funds]] (ETFs) traded in the US and managed by [[State Street]]. The [[SPDR Trust Series I (SPY)]] fund engineers the returns generated by the S&P 500 index through holding the companies in the index in the same proportion as the index. Investors can use other SPDRs such as [[XLE]] (Energy) or [[XLB]] (Basic Industries), to invest in a specific of the US economy.

Revision as of 16:44, September 6, 2008

The S&P 500 is a stock market index containing the stocks of 500 American Large-Cap corporations. The index is the most notable of the many indices owned and maintained by Standard & Poor's, a division of McGraw-Hill. The S&P 500 index forms part of the broader S&P 1500 and S&P Global 1200 stock market indices.

All of the stocks in the index are those of large publicly held companies and trade on the two largest US stock markets, the New York Stock Exchange and Nasdaq. After the Dow Jones Industrial Average, the S&P 500 is the most widely watched index of large-cap US stocks. It is considered to be a bellwether for the US economy and is a component of the Index of Leading Indicators. It is often quoted using the symbol SPX or INX, and may be prefixed with a caret (^) or with a dollar sign ($).

Many index funds and exchange-traded funds track the performance of the S&P 500 by holding the same stocks as the index, in the same proportions, and thus attempting to match its performance (before fees and expenses). Partly because of this, a company which has its stock added to the list may see a boost in its stock price as the managers of the mutual funds must purchase that company's stock in order to match the funds' composition to that of the S&P 500 index.

In stock and mutual fund performance charts, the S&P 500 index is often used as a baseline for comparison. The chart will show the S&P 500 index, with the performance of the target stock or fund overlaid.

Composition of the S&P 500 Index

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S&P 500 sector break-down[1]

The S&P 500 index contains 500 large-cap companies which represent all the major industries in the U.S. economy. The companies are chosen by a team of index analysts and economists at Standard & Poor's who meet on a regular basis and follow a set of published guidelines for maintaining the index. The goal of the committee is to ensure that the index remains a leading indicator of U.S. equities, and reflects their risk and return characteristics. All the stocks in the index trade in the New York Stock Exchange or the NASDAQ.

The S&P 500 index is not made up of the 500 largest corporations in the U.S., since other factors such as liquidity of the stock and industry grouping are also considered in selecting members for the index. For example, Berkshire Hathaway is not included in the S&P 500 index since it is a holding company and does not meet liquidity guidelines due to its high share price.

The criteria for being added to the index are as follows:

  • Must be a "U.S. company". This is determined by looking at location of company's operations, its corporate structure, its accounting structure and its exchange listing.
  • Must have minimum $5 billion market capitalization. The minimum is reviewed occasionally to ensure that it takes in to account market conditions.
  • Must have a minimum public float of 50%, which means that at least half of the company's share must be publicly tradable.
  • Must be financially viable. Companies are expected to have at least four consecutive quarters of positive as-reported earnings
  • Should have adequate liquidity and reasonable price. The ratio of annual dollar value traded to market capitalization for the company should be 0.30 or greater. Very low or extremely high priced shares are also considered to be illiquid.
  • The index must remain reflective of the various sectors in the U.S. economy. This signifies that even if a company has all the qualifying characteristics, it may not be selected if the sector it operates in is already accounted for in the index.
  • Constituents must be operating companies. Closed-end funds, holding companies, partnerships, investment vehicles and royalty trusts are not eligible while Real Estate Investment Trusts (REITs) and business development companies (BDCs) are eligible for inclusion to the index.

It should be noted that these criteria are applicable to companies that are being added to the S&P 500. Since the index committee attempts to minimize unnecessary turnover in index membership, existing companies does not have to diligently maintain these conditions to remain in the index. However, companies that substantially violate one or more of these criteria are removed from the index and replaced by a new company. As a result, on a year-to-year basis, the constitution of the index only changes slightly.

As of June 2008, the largest constituents of the index were[2]:

Company Adjusted Market Cap ($ billions) Index Weight
Exxon Mobil465.74.17%
General Electric2662.38%
Microsoft220.41.97%
Chevron2051.84%
AT&T200.21.79%
Procter & Gamble185.71.66%
Johnson and Johnson181.31.62%
IBM162.81.46%
Apple1481.32%
ConocoPhillips145.61.30%

Index Calculation

The S&P 500 used to be a market-value weighted index, and therefore changes in price for companies with higher market capitalization would had a proportionally larger impact on the index. For example: In June 2008, Exxon Mobil's weight in the S&P 500 Index was roughly 4.2%. If Exxon Mobil's market capitalization increased by 10%, it would cause the S&P 500 to rise by

10%*4.2% = 0.42%

On the other hand, Apple's weight in the index, in June 2008, was 1.3%. Therefore if Apple's market capitalization increased by 10%, it would cause the index to rise by

10%*1.3% = 0.13%

In 2005, the Index was changed to be "float" weighted, i.e. the index weighting is determined by the amount of shares available for public trading. It works the exactly the same way as the market-cap weighting, only that instead of making each component proportional to their respective market capitalization, they are made to be proportional to their public float. When Google was included in the index in March 2006, only its Class A shares, which are publicly traded, were used to determine Google's weight in the index.Only a minority of companies in the index have this sort of public float lower than their total capitalization; for most companies in the index S&P considers all shares to be part of the public float and thus the capitalization used in the index calculation equals the market capitalization for those companies.[3]

Investing in the S&P 500 Index

Due to the mandate of the Index committee to keep the index representative of the US economy, the S&P 500 forms one of best gauges of the US economy. Therefore, investing in the index is roughly equivalent to placing bets on the US economy. The retail investors can place bets on the S&P 500 through several ways:

  • Mutual fund's such as Vangaurd Index Trust 500 also provide investors with engineered S&P 500 returns. Vanguard is widely regarded as the lowest cost ETF manager.

Moreover, the top 45 companies in the index constitute 50% of the index. Thus an average investor could engineer the index to a great extent by holding those companies in the right proportion.

References

  1. Standard and Poor's 500 Index Factsheet, retrieved 8/29/08
  2. Standard and Poor's 500 Index Factsheet, retrieved 8/29/08
  3. S&P 500, Wikipedia.org, Retrieved September 3, 2008
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