When it comes to the major U.S. stock indexes, the S&P 500 index is considered the best gauge of the overall stock market's performance and an indicator of how large U.S. corporations are performing.
With that in mind, here’s what all investors should know about the S&P 500 index, how it works, how you can invest in it, and why doing so could be a smart move.
Why use the S&P 500?
You may be wondering why the S&P 500 is considered so useful as a market and economic indicator.
Because the S&P 500 consists of a broad basket of stocks, it contains the companies most widely owned by individual investors. In fact, the 500 companies account for roughly 80% of the overall value of the stock market in the U.S.
Company weighting formula and calculation
The weighting formula for S&P 500 stocks is fairly straightforward. First, the company's market cap is determined by multiplying each company's outstanding share count by its current share price.
Next, the market caps of all S&P 500 components are added together. Each company's market cap is then divided by the total to determine its weight in the index. For example, if the combined market cap of all S&P 500 companies is $40 trillion and one company has a $1 trillion market cap, it would make up 2.5% of the index by weight.
S&P 500 vs. other major indexes
Although the S&P 500 is widely regarded as the best gauge of how the U.S. stock market is doing, there are several other indexes that can be useful for investors as well, including:
- Dow Jones Industrial Average
- Nasdaq Composite
- Russell 2000 (small-cap index)
S&P 500 vs. Dow Jones Industrial Average
The Dow Jones Industrial Average is a price-weighted index, meaning that the companies with the highest stock prices have the most influence on the index, regardless of their valuations. The Dow only lists 30 companies and excludes some of the largest stocks in the market -- for example, Amazon, Alphabet, and Berkshire Hathaway.
Because the Dow is price-weighted, Goldman Sachs (GS +0.87%), with a nearly $800 share price currently, has about eight times as much influence over the Dow's performance as Walmart (WMT -0.26%), despite Goldman's market cap being roughly one-fourth of Walmart's.
For these reasons, the S&P 500 is considered by most experts to be a better stock market indicator.
S&P 500 vs. the Nasdaq
The obvious difference between the S&P 500 and the Nasdaq Composite Index is that stocks in the latter must be listed exclusively on the Nasdaq market. The S&P 500 is a mix of both Nasdaq and New York Stock Exchange (NYSE) stocks.
You may also notice that when tech stocks are underperforming, the Nasdaq Composite tends to underperform the S&P 500 as well. That's because the Nasdaq has a higher proportion of technology stocks than the broader market, so it is more of a tech-heavy index.
Another key difference is that while the S&P 500 consists of large-cap stocks, the Nasdaq Composite contains all qualified stocks listed on the Nasdaq exchange, so it's more diverse in terms of market caps represented.
S&P 500 vs. the Russell Indexes
The Russell Indexes are designed to provide benchmarks for the entire stock market. The Russell 1000 is the closest comparison to the S&P 500 since it's a large-cap stock index that consists of 1,000 stocks (twice as many as the S&P 500) and is representative of about 93% of the stock market.
There is also the more popular Russell 2000 index, which is considered the best benchmark of how small-cap U.S. stocks are doing. Collectively, the Russell 1000 and Russell 2000 are known as the Russell 3000, which is a total stock market benchmark index.
Related investing topics
Is investing in the S&P 500 right for you?
Legendary stock market investor Warren Buffett has famously said that a low-cost S&P 500 index fund is the best investment that most people can make. It’s not difficult to see why:
- Over long periods, the S&P 500 has delivered annualized total returns of 9% to 10%.
- You can easily invest in a passive S&P 500 fund with virtually no investment fees.
- Investing in the S&P 500 is a maintenance-free investment you can simply buy and leave alone.
- Investing in the S&P 500 is a way to get broad exposure to the profitability of U.S. businesses without too much exposure to any individual company’s performance.
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