The Standard & Poor's 500 Index (S&P 500) is one of the most commonly used benchmarks for determining the state of the overall economy. Investors also use the as a benchmark for their individual portfolios.
The Dow Jones Industrial Average (DJIA) is another popular benchmark, and while it serves its purpose, it is much more limited in scope as it only contains 30 companies while the S&P 500 contains 500.
The S&P 500 has generally become the leading stock index due to its broader scope, and investors and analysts use its performance to judge the overall economy. Additionally, many hedge funds compare their annual performance to the S&P 500, seeking to realize alpha in excess of the index's returns. Below are some of the advantages and disadvantages of using the S&P 500 as a benchmark.
Key Takeaways
- The S&P 500 is largely considered an essential benchmark index for the U.S. stock market.
- Composed of 500 large-cap companies across a breadth of industry sectors, the index captures the pulse of the American corporate economy.
- Limited to just large-caps, however, the index misses the much larger swath of mid- and small-cap stocks that make up most of the economy.
- As a market-cap-weighted index, this benchmark also gives disproportionate weight to the largest companies, which thus make up the bulk of the index.
Advantages of Using the S&P 500 as a Benchmark
The key advantage of using the S&P 500 as a benchmark is the wide market breadth of the large-cap companies included in the index. The index can provide a broad view ofthe economic health of the U.S. because it covers so many companies in so many different sectors.
In addition to its broad scope, another advantage of the S&P 500 is that the components of the index are updated on a quarterly basis. A committee determines which companies to include in the index. The factors considered include a market capitalization of $14.5billion, a public float of at least 50%, and headquarters in the U.S.
Companies must have traded for at least 12 months after their initial public offerings (IPO) before being considered for inclusion in the index.By updating the index components, the index can accurately reflect the state of the large-cap market.
There are many other indexes that investors can look to in addition to the S&P 500, such as the NASDAQ 100, the Russell 2000, the NYSE Composite, and the FTSE 100.
Disadvantages of Using the S&P 500 as a Benchmark
There are also some disadvantages to using the S&P 500 as a benchmark for individual portfolio performance. Most investors are widely diversified in assets other than stocks, such as bonds, precious metals, and cash; values of which are not reflected in the S&P 500.
Also, the index contains only larger market-cap companies from the U.S. In contrast, investors may own small-cap or foreign companies in their portfolios. Using the S&P 500 as a benchmark may be an inaccurate measure of portfolio return for individual investors.
Another drawback to using the S&P 500 for benchmark purposes is that the index is disproportionately weighted towardlarger companies. The top 10 holdings, which include some of the largest companies in the world—Apple (AAPL), Microsoft (MSFT), Amazon.com (AMZN), etc.—make up 30.6% of the S&P 500.
The S&P 500 uses a weighted market capitalization for its construction. The index takes the number of shares multiplied by the current market share price to determine the market capitalization for each company. All the market capitalizations are then added together and then divided by a number known as the index divisor. The result of that calculation is the index value.
What Is the S&P 500 10-Year Return?
As of July 2023, the 10-year return for the S&P 500 is 172.2%.
Is the S&P 500 Always a Good Investment?
Whether or not the S&P 500 is a good investment will depend on the individual investor, their risk tolerance, and their investment goals. Generally, yes, the S&P 500 is a good investment because over time the index always has a positive performance so investors would see a return on their investment; however, as with all investments, timing matters. Investing in the S&P 500 is a better investment if you are investing for the long term.
Can You Invest in the S&P 500?
You cannot directly invest in the S&P 500 because it is a market index. The easiest way to invest in the S&P 500 is by investing in an exchange-traded fund (ETF) that tracks the index, such as the SPDR S&P 500 ETF Trust.
The Bottom Line
The S&P 500 works well as a benchmark for the broader economy because it includes 500 companies in the U.S. across all sectors. The performance of the index is an indicator of the performance of the overall economy. Though not perfect, because it is made up of only large-cap companies, and limited to just stocks in the U.S. and no other asset or foreign entities, the index is still used by investors to gauge the performance of their portfolios.
FAQs
Advantages of Using the S&P 500 as a Benchmark
Why is the S&P 500 index useful to investors? ›
The S&P is a float-weighted index, meaning the market capitalizations of the companies in the index are adjusted by the number of shares available for public trading. Because of its depth and diversity, the S&P 500 is widely considered one of the best gauges of large U.S. stocks, and even the entire equities market.
What is the S&P 500 and why is it used as a market indicator? ›
The S&P 500 is a stock market index that measures the performance of about 500 companies in the U.S. It includes companies across 11 sectors to offer a picture of the health of the U.S. stock market and the broader economy.
Why do investors use benchmarking? ›
Market benchmarks are important because they allow investors to compare their holdings' performance against reliable metrics.
Why might an investor prefer the S&P 500 over the DJIA? ›
Investors might prefer the S&P 500 over the DJIA as a gauge of the U.S. stock market's performance because the S&P 500 offers better diversification and a more comprehensive representation of the market due to its larger number of companies and wider industry coverage.
Why do investors use the S&P 500 as a benchmark? ›
The S&P 500 has generally become the leading stock index due to its broader scope, and investors and analysts use its performance to judge the overall economy. Additionally, many hedge funds compare their annual performance to the S&P 500, seeking to realize alpha in excess of the index's returns.
Why might the Standard & Poor's 500 index be a better measure of stock market performance than the Dow Jones Industrial Average? ›
The Dow tracks 30 large U.S. companies but has limited representation. The Nasdaq indexes, associated with the Nasdaq exchange, focus more heavily on tech and other stocks. The S&P 500, with 500 large U.S. companies, offers a more comprehensive market view, weighted by market capitalization.
What is the benchmark index in the stock market? ›
A benchmark index is like a collection of stocks or other instruments that shows how a specific market or part of the market is doing. It's a way to check how well an investment portfolio is doing compared to the whole market or a particular section of it.
What is the purpose of the S&P rating? ›
The mission of S&P Global Ratings is to provide high-quality, objective, independent, and rigorous analytical information to the marketplace.
How does the S&P 500 affect the stock market? ›
The S&P phenomenon occurs when index funds and other investment vehicles tracking the S&P 500 Index buy a stock upon the announcement of its inclusion to the index. The buying surge puts upward pressure on the stock. The price increase is mostly temporary, settling down after S&P-related buying subsides.
Benchmarking is the process of comparing your business's performance to that of others in your industry. This can help you identify areas where you shine and need improvement. Benchmarking has many benefits, including improving productivity, increasing efficiency, and gaining a competitive edge.
What is a benchmark that investors use? ›
Investors often use the S&P 500 index as an equity performance benchmark because the S&P contains 500 of the largest U.S. publicly traded companies. However, there are many types of benchmarks that investors can use depending on their investments, risk tolerance, and time horizon.
Why is it important to have a benchmark? ›
Benchmarking helps organizations to identify the areas where the gap between their standard and that of the industry is the largest. This helps organizations to prioritize the areas that they need to work on.
Why choose S&P 500? ›
Because each S&P 500 index fund contains hundreds of different stocks from a wide variety of industries, it offers fantastic diversification -- which is key to a healthy portfolio. In general, the more variety you have within your portfolio, the safer your investments will be.
Why might an investor prefer the S&P 500 over the DJIA Chegg? ›
Some say the S&P 500 is a better measure of stock market performance because it is broader. The Dow Jones Industrial Average ( DJIA ) and the Standard & Poor's 5 0 0 ( S&P 5 0 0 ) indexes are used as measures of overall movement in the stock market.
What is the purpose of a stock market index such as the S&P 500? ›
In this context, the S&P 500 is a common benchmark against which portfolio performance can be evaluated. The S&P 500 index is weighted by market capitalization (share price times number of shares outstanding). This means that a company's valuation determines how much influence it has over the index's performance.
What makes indexes useful for investors? ›
Indexes are useful for providing valid benchmarks against which to measure investment performance for a given strategy or portfolio.
How does market index help investors? ›
Indexes are used as benchmarks to gauge the movement and performance of market segments. Investors use indexes as a basis for portfolio or passive index investing.
What is an advantage of investing in an index fund like the S&P 500? ›
Over the long term, index funds have generally outperformed other types of mutual funds. Other benefits of index funds include low fees, tax advantages (they generate less taxable income), and low risk (since they're highly diversified).
What are the benefits of the stock market index? ›
Advantages of Indexes
Stock indexes provide an easy way to track the overall health of a market. By looking at one statistical measurement, it is easy to gauge the current state of the market.
