In the stock market, it is likely that you will encounter a specific type of measurement. It is incredibly handy and many investors and financial managers use it to describe the market. What’s more, it allows them to compare the return on specific investments. This goes by the name of ‘S&P 500 Index’, with S&P standing for ‘Standard & Poor’. Using it permits the measurement of the stock performances of 500 large companies on stock exchanges in the U.S. Many people see it as one of the best representations of the U.S. stock market.
An extension of this is the ‘S&P 500 Index fund’. There are several of these funds, but the best of this variety are usually those with the lowest expense ratios. This article will further explain what these funds are and what the best ones are.
What is it? What does it mean?
Generally speaking, an S&P 500 index fund is an investment vehicle. It can come in the form of either a mutual fund or an exchange-traded fund (ETF). It invests primarily in the 500 stocks that encompass the S&P 500 index in proportions that are market cap-weighted. The fees vary, however, they have a tendency of being remarkably cheap ways to invest.
The intent of S&P 500 Index funds is to replicate the performance of the benchmark index. A ‘benchmark’ is a standard against which a security, mutual fund or investment manager’s performance can be measured. These funds’ goal is possible by way of investing in S&P 500 constituents with comparable weights. The method of choice is utilizing a passive or indexing investment strategy. With this, they invest all – or at least a substantial amount – of their total net assets in common stocks. Specifically, ones that are in the benchmark index.
Maintaining low investment costs is the aspect of index fund investing that many investors know is crucial. That is to say, it is important when it comes to producing the best index funds. Put simply, the index funds that possess the lowest expense ratios typically generate the best returns over time. This, among other things, can be a notable advantage of using index funds instead of funds with active management.
Let’s assume that an index fund has an expense ratio of 0.12. Moreover, a similar actively managed fund has an expense ratio of 1.12. In this particular case, the index fund possesses an immediate 1.00% advantage over the fund with active management. Index funds typically have passive management, therefore there is a dramatic decrease in the costs of managing the fund.
Formula & Calculation
The S&P 500 employs the use of a specific market capitalization weighting method. It is what gives a higher percentage of distribution to companies that have the largest market capitalizations.
Company Weighting in S&P = Company market cap / Total of market caps
There is a certain technique for determining the weighting of each component of the S&P 500. This process begins with summing the total market cap for the index. Below is a step-by-step tutorial on what the procedure entails:
- Calculate the total market cap for the index. To do this, you need to add all the market caps pertaining to the individual companies.
- The calculation of the weighting of each company in the index is done by dividing the company’s market capitalization by the index’s total market cap.
- To elaborate, you calculate a company’s market capitalization by multiplying the current stock price by the company’s outstanding shares.
- Luckily, there is frequent publishing of the total market cap for the S&P – and the market caps – of individual companies. Their publication is specifically on financial websites. This continual publication saves investors the need to calculate them.
Contrary to popular belief, building an index fund goes beyond simply purchasing the representatives of securities in the index. There is more to cover in order to fully create an index fund and ensure good performance tracking. For this to happen, the management team and supporting staff need to determine how much of each holding to purchase. In other words, they need to determine the number of shares they will buy.
The principal idea behind this is to match the percentage “weighting” of the index itself. This introduces a new concept: capitalization-weighted indexes (aka. cap-weighted or market-cap-weighted indexes). These are indexes that rank the holdings in order for the larger components to obtain larger percentage weights.
A notable example – and appropriate given the topic of this article – of a cap-weighted index is the S&P 500. A majority of index funds will often mirror the cap-weighted index by way of buying shares of holdings. This effectively makes stocks with the largest capitalization the largest holding by percentage in the index fund. For example, imagine that ABC Corporation’s stock has the largest market capitalization. In this case, ABC Corporation’s stock will be indicative of the largest percentage of the index fund.
The importance of asset size
In the world of indexing, size holds great significance. An index fund that has high ‘assets under management’ (AUM) is more than an indication of quality. As a matter of fact, it is also an advantage. This is especially true when it comes to the subject of liquidity in ETFs. Upon comparison, you will find that an index fund with few assets may experience difficulties. Specifically, when it comes to keeping the portfolio perfectly weighted to the index.
Large mutual fund companies evidently have a large number of investors. These companies include the likes of The Vanguard Group, Charles Schwab, and Fidelity Investments. Because of their many investors, they have the proper assets to effectively manage the fund. For instance, they are able to purchase shares of holdings and provide liquidity to meet the demand for investor withdrawals.
The best of the best
It would be easy to assume that all S&P 500 index funds are pretty much the same. On the surface, that may appear true, but it actually isn’t. Indeed, there are plenty of similarities, like they all track the S&P 500 index. However, there are also some key differences that separate them. Probably the most noteworthy difference lies with the fees. Overall, their construction is done so in a way that closely matches the underlying index. Therefore, fees remain within a tight range along with the best funds. Nevertheless, there are some terrible funds out there that often charge an excessive amount.
With that in mind, there are plenty of S&P 500 Index funds to choose from. However, it is crucial for you to pick not only the best one but the one that is suitable for your preferences. At this point, you now know what these funds are and what it takes to make the better ones. Now, we will go over the best S&P 500 Index funds to choose from for your portfolio.
1 – Vanguard 500 Index Fund (VFINX)
The foundation of Vanguard was primarily on indexing and it is the earliest in the world of index funds. The intent of Vanguard 500 Index Fund Investor Shares is to provide investment results. To elaborate, results that correlate to the price and yield performance of the S&P 500 Index with positive equivalence. The total return generation of this fund over a three-year period is roughly 14.26%. The management of the VFINX is in the hands of the Vanguard Equity Investment Group. It charges an annual expense ratio of about 0.14%. You may notice that this is considerably lower than the average expense ratio of mutual funds with similar holdings.
There are two vital principles when it comes to successful investing: simplicity and moderation. Vanguard is a company that was able to master these virtues. It has a specific method that would help it achieve its investment objective. VFINX implements an indexing strategy and invests almost all of its total assets in stocks within the S&P 500 Index. Moreover, with almost the exact same proportions as the weightings that are in the index.
Similar to a lot of S&P 500 Index funds, VFINX is satisfactory for long-term investors. Particularly those with a moderate to a high degree of risk tolerance pursuing exposure to the U.S. large-cap equities market. VFINX possesses a diminutive tracking error and a very low expense ratio. This is why it is such an appealing core holding for an equity portfolio.
2 – Schwab S&P 500 Index Fund (SWPPX)
In May of 1997, the Charles Schwab Corporation would officially issue the Schwab S&P 500 Index Fund. The advisory and management of the SWPPX are by Charles Schwab Investment Management, Inc. The expense ratio it charges is roughly 0.02%.
SWPPX is a mutual fund that aims to provide investment results correlating with the S&P 500 Index’s total returns. To go about achieving this investment goal, SWPPX typically invests at least 80% of its total net assets in stocks. Moreover, consisting of the S&P 500 Index. In addition, SWPPX will customarily give the same weights to these stocks as the index.
The SWPPX has approximately $41.3 billion under management, as well as a portfolio turnover of about 2%. SWPPX also has the following:
- A beta of 1.00
- An alpha of -0.03
- A Sharpe ratio of 1.07
- A standard deviation of 12.06
3 – Fidelity 500 Index Fund (FXAIX)
In February of 1988, Fidelity would issue the Fidelity 500 Index Fund. This particular fund provides its consumers with low-cost exposure to the U.S. large-cap equities market. The annual net expense ratio that FXAIX charges are about 0.015%.
Ever since its initiation, the fund would go on to successfully generate 10.42% in annual average returns. There is a specific method FXAIX uses for tracking the underlying index. It invests at least 80% (under normal market conditions) of its total net assets in common stocks encompassing the index. FXAIX’s historical tracking of the index was with only a small degree of tracking error.
FXAIX essentially functions as an alternative to VFINX and SWPPX. What’s more, it’s one of the top funds supplying exposure to a basket of common stocks in the S&P 500 Index. FXAIX will often act as a core holding within a portfolio of U.S. equities.
4 – T. Rowe Price Equity Index 500 Fund (PREIX)
The launch of the T. Rowe Price Equity Index 500 Fund (PREIX) took place in March of 1990. Since then, it would deliver a five-year average annual return of roughly 10.58%. The net expense ratio that PREIX charges is typically 0.21%. For tracking the S&P 500, the fund intends on matching the investment return of large-capitalization U.S. stocks. It aims to do so by seeking to match the overall performance of its benchmark index.
Drawing from trailing 10-year statistics, PREIX possesses a Sharpe ratio of about 1.0. Moreover, it has a standard deviation – or volatility – of 12.44%. The amount of total net assets that the PREIX has is roughly $30.9 billion. It is suitable primarily for investors that are looking to acquire exposure to the U.S. large-cap equities market.
5 – iShares Core S&P 500 Fund (IVV)
Generally speaking, this fund is a traded ETF whose purpose is to track the S&P 500. Investors usually find IVV appealing because they could potentially get S&P 500 exposure at a low holding cost. On average, this particular ETF trades up to 850 million shares per day. IVV integrates the largest capitalization of U.S. stocks in one portfolio. Moreover, it focuses largely on tax efficiency and long-term growth.
Deciding to invest in index funds can often prove to be a long-lasting investment. On top of that, it can be a great – not to mention easy – way to diversify a portfolio. Admittedly, the stock market will continue to have its highs and lows. However, the long-term trend pertaining to the S&P 500 index is positive; to an overwhelming degree in fact. With this success rate, it gives the chance for a low-risk investment opportunity.
If you want to invest in an index like one of the ones above, you will first need to create an investment account. You can do so through one of the many brokerages that are available. There is a wide variety of features and pricing among these brokers, so realistically speaking, selecting one can be difficult. Hopefully, this article will provide the aid you need in making a decision.