Most of us are used to hearing on the news about "the market" and how it did today, without really giving much thought to just what "the market" is. Of course, that term usually refers to the U.S. stock market, and that's typically measured by the Dow Jones Industrial Average index or the S&P 500 (SNPINDEX:^GSPC) index.

Savvy investors should know more than that, though, so here's a deeper dive into the S&P 500, so that you can make more sense of it and perhaps even invest in it, as none other than Warren Buffett has suggested you do.

"S&P 500" in 3-D, over planks of wood or a wood floor

Image source: Getty Images.

It's old

The S&P 500 was launched in March 1957, when a gallon of gas cost around $0.28 and the same year that a young Elvis Presley purchased Graceland. The index originally held 425 industrial, 15 rail, and 60 utility stocks. Financial companies were added in the 1970s.

It makes up most of the market

The S&P 500 has, not surprisingly, 500 component companies. That might seem like a relatively modest number, since there are several thousand companies traded publicly in the U.S. market. It's not, though, because these are 500 of the biggest companies in America, and together they make up about 80% of the overall market's value. Thus, as Standard & Poor's itself says, "The S&P 500 is widely regarded as the best single gauge of large-cap U.S. equities."

The top holdings recently were Apple, Microsoft, Amazon.com, Facebook, ExxonMobilJohnson & JohnsonBerkshire Hathaway, JPMorgan Chase, and Google parent Alphabet. Here are the recent sector allocations:

Sector

Percent of Assets

Information Technology

22.5%

Financials

14.1%

Health Care

14%

Consumer Discretionary

12.5%

Industrials

10.2%

Consumer Staples

9.3%

Energy

6.3%

Utilities

3.2%

Real Estate

2.9%

Materials

2.9%

Telecommunication Services

2.3%

Data source: S&P Dow Jones Indices 

To get into the S&P 500, companies must meet various criteria, such as having a market capitalization of at least $6.1 billion (this threshold changes over time) and a minimum trading volume of 250,000 shares per month in each of the six months before a stock's evaluation for entry.

Man in suit with giant magnet, attracting lots of dollars

Image source: Getty Images.

It features dividends

The S&P 500, as it encompasses many dividend-paying stocks, sports its own dividend yield, which was recently  about 2%. There are many companies with fatter yields than that, such as:

Company

Recent Dividend Yield

AT&T

5.1%

Pfizer

3.9%

General Electric

3.4%

Intel

3.1%

McDonald's

2.5%

Data source: Yahoo! Finance.

But the S&P 500's 2% yield is far from inconsequential, recently topping the yields of companies such as the following:

Company

Recent Dividend Yield

Apple

1.6%

Starbucks

1.6%

Walt Disney

1.5%

Nike

1.4%

Citigroup

1%

Data source: Yahoo! Finance.

It's used to gauge the market's valuation

Just as many investors look at a stock's price-to-earnings (P/E) ratio for a very rough sense of whether it's overvalued or undervalued, many people take the pulse of the overall U.S. stock market by looking at the S&P 500's numbers. Indeed, some raised an alarm in March, when the S&P 500's cyclically adjusted P/E (CAPE) ratio hit 30 for only the third time since 1871. That suggested that the index (and therefore the market) had gotten ahead of itself and might be due for a fall -- as it did fall after the two previous high points. (The measure has since receded a little.)

Graphic of the stock market, with green dollar signs floating in front of stock prices

Image source: Getty Images.

It's market-weighted

One of the most important things to understand about the S&P 500 index is that it's market-cap-weighted -- and it's the first U.S. market-cap-weighted index, for that matter. The much older Dow Jones Industrial Average, which comprises just 30 companies, is, by contrast, price-weighted.

What's the difference? With a price-weighted index, the stocks with the highest prices will have the most influence, no matter how big or small the underlying company is. For example, 3M, with a recent stock price near $200 per share, will have a greater influence on the Dow than will Apple, as its stock price was recently just $152. To understand the wackiness of this method of constructing an index, consider that while 3M's market capitalization was recently around $117 billion, Apple was the most valuable company in the world, with a market cap of about $800 billion! Since the Dow is so old, dating back to the 1880s. and has done things this way for so long, though, it's unlikely to change.

Market-cap-weighted indexes make more sense. In the S&P 500, Apple more reasonably has a far greater influence than does 3M -- nearly seven times as much. This system isn't perfect, either, though. While Apple recently carried a weighting of 3.9%, and other big companies such as Facebook, Procter & Gamble, and Home Depot sported weightings of close to or more than 1%, hundreds of companies were weighted less than 0.2%. Indeed, many, such as Harley-Davidson, Western Union, and Mattel, were well below 0.05%, making their influence on the overall index rather minimal.

Red jigsaw puzzle piece near white ones. "Time to" is printed on one piece and "invest" is on the red one.

Image source: Getty Images.

It outperforms most mutual funds

Many people assume that stock mutual funds that are managed by financial professionals who study stocks closely, deciding which to buy and sell, perform better than simple index funds such as those based on the S&P 500. After all, such index funds just hold the same stocks as the index, with little decision-making required. In fact, though, index funds tend to outperform their actively managed counterparts over long periods. According to Standard & Poor's, as of the end of 2016, fully 83% of all domestic stock mutual funds underperformed the S&P 1500 Composite Index over the past 10 years, while 85% of large-cap stock funds underperformed the S&P 500.

It's easy and inexpensive to invest in

Since so many managed stock funds can't beat the S&P 500, it makes good sense to just invest in an S&P 500 index fund. Even billionaire Warren Buffett, known for his investing brilliance, endorses that idea. He says that in his will, he offers these instructions for the money left for his wife: "Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. (I suggest Vanguard's.)" You can do so through many index funds from many fund companies -- just be sure to choose one with low fees, as there are very low fees to be found. A particularly easy way to invest in the S&P 500 is through an exchange-traded fund (ETF) such as the SPDR S&P 500 ETF Trust (NYSEMKT:SPY). ETFs work much like stocks, letting you buy as many or as few shares as you want throughout the trading day. A SPY share recently traded for about $238 per share, sported a dividend yield of close to 2%, and charged just 0.1% in annual fees.

Knowing what the S&P 500 is can help your portfolio's performance. You might, for example, put much of your 401(k) or IRA funds in an S&P 500 index fund. And you might simply put much of your stock-investing money in one, if your long-term results so far aren't beating the S&P 500.

Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Teresa Kersten is an employee of LinkedIn and is a member of The Motley Fool's board of directors. LinkedIn is owned by Microsoft. Selena Maranjian owns shares of Alphabet (A shares), Alphabet (C shares), Amazon, Apple, Berkshire Hathaway (B shares), Facebook, General Electric, Johnson & Johnson, JPMorgan Chase, Microsoft, Procter & Gamble, Starbucks, and Walt Disney. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), Amazon, Apple, Berkshire Hathaway (B shares), Facebook, Johnson & Johnson, Nike, Starbucks, and Walt Disney. The Motley Fool owns shares of ExxonMobil and General Electric. The Motley Fool recommends Home Depot and Intel. The Motley Fool has a disclosure policy.