I thought I knew everything important about the S&P 500:
- It contains 500 of America's biggest companies, including ExxonMobil (NYSE:XOM), General Electric (NYSE:GE), and Home Depot (NYSE:HD).
- It's basically a market-cap-weighted index, meaning that the bigger the component company, the more of it the index holds, proportionately. (OK, OK -- it's technically a "float-weighted" index now, ignoring those shares of each company that are not freely floating on the market. But for most companies, this doesn't make much difference.)
- Many index funds and exchange-traded funds (ETFs) are tied to it. These index funds are excellent long-term investments for many, if not most, people. They deliver the market's return, which has averaged about 10% a year over long periods. (This is no secret -- more than a trillion dollars is invested in the index!)
- Its components are selected by a committee, not by any automatic screening or set of quantitative criteria. They don't represent the 500 biggest companies, but rather 500 of the biggest companies. They're also chosen to reflect a wide spectrum of industries. Together, they represent about three-quarters of the value of the entire U.S. stock market.
- The S&P 500 has been hard for most mutual funds to beat, with the vast majority underperforming it. (We'd love to point you to some stellar stand-out funds, though, with market-beating records and rosy futures.)
The lesser-known side of the S&P
That covers the basics. But recently, several interesting articles commemorating the index's 50th birthday offered a few tidbits I hadn't heard before.
In a MarketWatch article by Jonathan Burton, I learned that dividends account for a full third of the index's historic return. In addition, nearly half of the revenue that S&P 500 companies earn comes from outside of the U.S., and ExxonMobil, the biggest S&P 500 company at 3.3% of the index, derives around 70% of its sales from foreign sources. This is good news for those investors interested in international investments. To a large degree, you don't have to leave home now to invest abroad. A simple S&P 500 index fund investment will give you a lot of international exposure.
The implications of the index being capitalization-weighted are interesting. For example, the top 10 component companies in the index make up a fifth of its value! In other words, 2% of the companies are responsible for 20% of the value. The top 50 companies (10% of the group) contribute nearly half of its value. This means that while you, as a shareholder, might be pleased to own such a wide swath of American industry, your holdings are still rather concentrated, giving you much more of the biggies and much less of the small fries.
Tougher than you think
At fundalarm.com, Roy Weitz noted that the first major S&P 500 index fund actually included just 481 stocks. Wells Fargo (NYSE:WFC), which created the fund, chose not to buy 19 stocks that were having financial difficulty. As it turns out, those 19 companies did far better than the other 481.
Even though the first index fund didn't manage to match the index, there are funds out there with market-beating records over long periods. If you don't know where to best invest your money, you could do much worse than simply opting for an S&P 500 index fund -- or an even broader index fund, such as Vanguard's Total Stock Market ETF (AMEX:VTI). But if you'd like to try to do even better with some of your money, dig into the world of managed mutual funds, which contains some excellent contenders.
We'd love to help you find them, too -- so I encourage you to take advantage of a free trial of our Motley Fool Champion Funds newsletter. It has recommended many terrific funds (I've invested in a handful, myself) -- and its recommendations, on average, are beating their respective benchmarks by some 13 percentage points. (Click here to try it for free for a whole month, which will give you full access to all past issues and all recommended funds.)
Longtime contributor Selena Maranjian owns shares of General Electric and Home Depot, the latter of which is an Inside Value pick. The Motley Fool is Fools writing for Fools.
