The S&P 500 Explained
Everything You Need to Know About Investing in the S&P 500
First, a quick update from me. My Money With Carla Event in Cape Town 2 weeks ago was a big success! It received an overall 9.4/10 enjoyment rating and 100% of participants said they left feeling more confident to invest in the stock market - how amazing!
I’ll be hosting my next event in Johannesburg on 16 November.
Now, back to business.
The S&P 500 might initially sound complex, but it's one of the most straightforward ways to start investing in the stock market. I recently published a YouTube video on this topic if you’d like to watch this in video format.
In this blog, we'll look at:
what the S&P 500 is,
how it works,
the best ways to invest in it through ETFs, and
why it’s a great (but not the only) option for your portfolio
What is the S&P 500?
The S&P 500, short for Standard & Poor's 500, is a stock market index that tracks the performance of 500 of the largest publicly traded companies in the US. These companies span across different industries, from tech giants like Apple and Google to consumer staples like Coca-Cola and Starbucks.
Think of the S&P 500 like a sports team. Instead of picking a single player (stock), you’re investing in the entire team, representing 500 players (companies).
This gives you a piece of all the sectors, including technology, healthcare, and financial services, which is why it's seen as a great way to gain broad exposure to the US economy (the biggest economy in the world).
When people say “the market is up” or “the market is down,” they are often referring to this index because it’s widely regarded as a key indicator of the stock market’s overall performance.
How Does an S&P500 ETF Work?
You cannot invest in the S&P500 index directly, but you can get access to it through an ETF, or Exchange-Traded Fund. An ETF is like a basket that holds all the stocks in the index. When you buy shares in an S&P 500 ETF, you (indirectly) own a piece of all 500 companies, rather than investing in each one individually.
ETFs trade on stock exchanges, just like regular stocks. This means you can buy or sell them anytime the market is open. They're also known for having lower fees than actively managed funds since they don’t require a manager to hand-pick the stocks. In fact, the most popular S&P 500 ETFs, like the ones offered by Vanguard and iShares, charge fees as low as 0.03% to 0.20%.
Think about an index as tracking the average returns of the market. There is no bias involved in the company selection and you don’t have to pay anyone fees to do the selection for you. Also, you don’t want to pay someone because history shows us most cannot do better than the average (the index) after deducting their fees.
You can learn more about ETFs in this blog or this YouTube video.
Returns and diversification
The S&P 500 has a long history of delivering solid returns. On average, it has returned about 10.5% annually since the 1950’s. But while past performance is encouraging, it’s not an indicator of future performance and it’s important to remember that the stock market can be volatile.
This 10.5% return is quoted in USD, if your base currency is ZAR or GBP for example, remember you cannot compare these returns 1:1, read this blog to understand why. For example, in ZAR terms the S&P500 has returned 17% on average over 20 years.
One key reason investors flock to the S&P 500 is its diversification and its exposure to the biggest stock market in the world. You're not betting on a single company; you're spreading your investment across 500 of the largest US companies. These firms operate globally, which means you're also getting indirect exposure to international markets (more on this later).
However, diversification within the S&P 500 only goes so far. Since it’s focused on large-cap US stocks, you're missing out on smaller companies and non-US markets, both of which can offer growth opportunities and are good for diversification.
Choosing the Right S&P 500 ETF
I often get asked “What is the best S&P500 ETF?”. S&P500 ETF’s are all quite similar, in the sense that they all track the same 500 companies, so performance differences between them will be minimal. However, here are a few key things to watch out for:
Expense Ratio: This is the fee charged by the ETF. The lower the expense ratio, the less of your return goes toward fees, so aim for ETFs with the lowest fees possible.
ETF Domicile: Depending on where you live, the domicile of the ETF can impact your tax obligations. Some countries have tax treaties with the US that may make US-based ETFs more attractive. In other cases, you might want to opt for an ETF domiciled elsewhere to avoid US estate tax.
Accumulating vs. Distributing: Some ETFs reinvest dividends back into the fund (accumulating), while others pay out dividends to investors (distributing). Whether you prefer dividend income now or want to reinvest and grow your investment over time will influence your choice.
Should I Only Invest in the S&P 500?
While the S&P 500 is an excellent way to gain exposure to the US stock market, it shouldn't be the only thing in your portfolio. The index is heavily weighted toward large-cap US stocks, particularly in sectors like technology. This can leave you vulnerable if those sectors underperform.
For example, between 2007 and 2013, emerging markets outperformed the S&P 500. Therefore, it’s wise to diversify by adding international stocks, emerging markets, and smaller cap companies to your portfolio.
Of course, only holding equities in your portfolio is high risk (which should not invoke fear because in the long term, it means high reward). But, depending on your age, it’ll be smart to gradually move toward lower-risk assets such as bonds as you age. (Yes, I also have a blog on this. Read the “third principle” that I discuss in this blog.)
Even though the S&P 500 is a US index, many of the companies within it operate globally. A significant portion of their revenue comes from outside the US, meaning you are indirectly investing in the global economy.
For instance, Google (Alphabet) generates more than half of its revenue from outside the US, and this is the case for many other companies within the index. More than 40% of the revenues generated by companies within the S&P500 come from outside the US.
Also, the US represents 42.5% of the global stock market. Many people I speak to only have exposure to the South African or Swiss stock markets for example - which respectively represent less than 2% of the global stock market. So getting exposure to 42.5% of the global stock market is already a big move in the right direction if your starting point is less than 2% diversification.
Here’s an image to show the relative sizes of different countries’ stock markets:
Patience and Consistency
Investing in the S&P 500 is a smart move for long-term investors looking for a simple, low-cost way to gain exposure to the US stock market. But it’s just one part of a broader strategy. Make sure you diversify your investments to include international markets and smaller companies to get true global equity diversification.
And remember, while the S&P 500 has been a reliable investment, the key to success is patience and consistent investing. Stick with it, and you’ll likely reap the rewards over the long term.
I hope this gives you a strong foundation in understanding the S&P 500! For more investing insights, check out my YouTube channel where I share tips and experiences to help you on your investing journey. Stay tuned for my upcoming masterclass, too - you can join the waiting list here.
Disclaimer: This is not personal financial or tax advice. Always do your own research or speak to an adviser before making any investment decisions.