The most commonly used and quoted measure that financial market professionals and investors use to follow the ups and downs of the United States stock market is the S&P 500 Index. The S&P 500 is made up of five-hundred large publicly traded companies that have stock listed on the New York Stock Exchange and other large United States stock exchanges. The S&P 500 Index is followed by investors as a gauge of the overall health and movement of the stock market in general. When an investor or commentator reports that “the market was up one percent today,” they are usually referring to the day’s gain in the S&P 500. The index recently traded at a level of 2,975 points. However, an investor does not need to understand how the index is calculated or even what 2,975 points means. The value for the average investor in following the index lies in tracking of the gains and losses for the broad stock market which the S&P 500 measures.
The S&P 500 is a market capitalization weighted index. A public company’s “market cap” is simply the total current market value of that company. For example, Starbucks Corporation has 1.2 billion shares of stock outstanding. Each share recently traded at $96.25 per share. If we multiply the current value per share by the total number of shares outstanding, then we get a market cap of $115.5 billion. This means that if you wanted to purchase every share of Starbucks stock, it would cost you $115.5 billion.
There are 500 companies in the S&P 500 Index, but they are not all weighted equally in the index. Each company’s weight in the index is determined by its market cap. For example, Microsoft Corp. has the largest market cap in the index in 2019 with a market cap of $1.06 trillion. Nordstrom Inc. has the smallest market cap in the index at only $4.7 billion. Since the market cap of Microsoft is 225 times larger than the market cap of Nordstrom, Microsoft’s resulting weight in the overall index is considerably larger. Microsoft is a much larger part of the United States economy than Nordstrom is, so its representation and weight in the index is much greater. Microsoft has a 4.3 percent weight in the S&P 500 while Nordstrom has only a 0.1 percent weight in the index. So, a 1 percent decline in the price of a Microsoft share moves the S&P 500 much more than a 1 percent decline in a share of Nordstrom. That makes sense as their sizes and weights in the index are so different from each other.
Many stock market investors who want to gain exposure to investing in large United States stocks (but do not have the time, expertise or ability to research and purchase individual stocks) can invest in the broad stock market conveniently and at a low cost by buying shares of an S&P 500 fund. With one small purchase of this type of index fund, the investor now has investments in all five-hundred members of the index. An index fund is a very quick, easy, and cost-efficient way to invest in the stock market. Making regular and periodic investments in an S&P 500 fund is a great way to invest in the United States economy and to grow wealth over a long period of time, and it is most often the best choice for a small investor.
