Here's a Big Reason Why the S&P 500 Index Keeps Winning

Whitney Tilson knows a few things about investing. He has followed Warren Buffett for decades, managed a hedge fund, and written various newsletters and emails for investors, often focused on value investing.

I subscribe to one of his emails, and a point he made in it a few months ago made a big impression on me, as I hadn't thought of it before. He offered an excellent reason why the S&P 500 index keeps winning. That reason can help each of us invest better, too.

Image source: Getty Images.

What's the S&P 500 and how is it winning?

The S&P 500 index is a collection of about 500 of America's biggest and best companies. Together, these companies represent about 80% of the entire U.S. stock market's value, even though there are thousands of publicly traded U.S. companies. Here are the index's recent top holdings:

Data source: Slickcharts.com.

One of the virtues of broad-market index funds is that indexes such as the S&P 500 tend to outperform non-index mutual funds. For example, according to the folks at S&P Dow Jones Indices, over the past 15 years, the S&P 500 index outperformed a whopping 88% of managed large-cap mutual funds (that is, funds with managers who actively pick and choose investments, deciding when to buy and/or sell them).

Why is the S&P 500 index winning?

So why does the S&P 500 index, and lots of index funds that track it, tend to outperform funds where well-paid professionals are trying hard to beat it? A commonly cited reason is simply: fees. Fees can make a huge difference in your long-term returns.

Here's another reason the S&P 500 index keeps winning, offered by Tilson: It hangs on to its winners!

Indexes such as the S&P 500 and the Dow Jones Industrial Average ("the Dow") adjust their holdings now and then, kicking out one or more companies that no longer fit the bill and adding others. Just last month, for example, Super Micro Computer and Deckers Outdoor were added to the S&P 500, while Whirlpool and Zions Bancorporation were shown the door. But in general, each index doesn't change all that much from month to month and year to year. (And on most days, such indexes don't change their composition at all.)

That makes indexes rather different from many investors. They might invest in a bunch of companies they are bullish on, but when the stocks hit a rough patch, they often sell. Or they sell after notching a pleasing gain, such as a 50% return or even a doubling of their investment.

Those who hang on to healthy and generally growing companies for years and years, though, through ups and downs -- even sharp downs -- can end up with amazing long-term gains. Think of Netflix, for example, which took a dive after introducing its Qwikster service.

Or think of semiconductor titan Nvidia, which has had an amazing run, averaging eye-popping annual gains of 70% over the past decade. Along the way, it dropped some 31% in 2018 and 50% in 2022. Plenty of investors probably got scared by such drops and sold -- only to lose out on hefty subsequent gains.

Great companies often change direction a little or a lot over the years. Nvidia, for instance, has morphed from being largely a gaming chip maker to specializing in data centers while developing artificial intelligence (AI) technology, as well. Netflix went from offering movies by mail to a wider assortment of entertainment, some original to Netflix, via streaming. Investors who hung on through these changes have been well rewarded. Such companies are also a big part of how the S&P 500 has been able to post such solid gains, on average, over many years.

How to profit via the S&P 500's winning ways

So what can investors do with these insights? Plenty. For starters, you should always pay attention to fees, whether in mutual funds, ETFs, or other investments, aiming to avoid high fees and favor low ones.

You should also aim to hang on to your winners for a long time. Sure, having a great stock double for you is terrific. But if it's still a great stock with solid growth prospects, it might well double again for you -- and then again and again. Selling prematurely can be a costly error. Just be sure you're keeping up with the company's developments and progress, to make sure it's still performing well and earning your confidence.

And if all that keeping up with lots of stocks sounds like too much work -- or like something you won't even be good at -- consider just investing in index funds -- such as the Vanguard S&P 500 ETF. They have delivered market-meeting returns over long periods and can help you amass the money you need for retirement. Remember that many millionaires have become millionaires by playing the long game.