Learning how to invest in the S&P 500 got a lot easier after 1976.
That is the year that John Bogle, founder of Vanguard, created the first index fund. This new type of investment fund allowed everyday investors, like you and me, to invest in indices (such as the S&P 500 and Dow Jones Industrial Average) with just one purchase.
Without index funds, if you wanted to invest in the S&P 500, you’d either have to buy each stock individually through 500 separate transactions or pay a mutual fund manager too much money to try to recreate the index themselves.
Index funds enable people to invest in the S&P 500 with just one purchase, and for a very low cost.
What is the S&P 500?
The S&P 500 is an index that tracks 500 of the largest publicly-traded companies in the United States. It’s often used as a proxy to track how the total US Stock Market is performing.
The S&P 500 is a stock market index that tracks the performance of 500 of the biggest companies in the United States.
The “S&P” in S&P 500 stands for Standard and Poor’s. For a while, these were two separate companies, Standard Statistics Company and Poor’s Publishing, that each provided different investing guides and advice. However, in 1941 they merged to form Standard and Poor’s, and in 1957 they created the first iteration of the S&P 500 index.
The “500” of course refers to the 500 large and publicly traded companies that made the list. The companies in this index are selected by a committee which base their decision on criteria such as market capitalization, industry, liquidity, and more.
Last, it’s important to note that the S&P 500 is a market capitalized index. This means that each company within the index does not make up an equal share of the index.
For example, Microsoft is not 0.2% of the index (1/500). Microsoft is a huge company with a huge market cap, and it makes up over 4% of the S&P 500 index.
On the flip side, the smallest of the 500 companies will make up less than 0.2% of the index, in line with their market cap as well.
Market Cap = Share Price times Number of Shares.
Three Steps to Invest in the S&P 500: Building a Single Fund Portfolio
As mentioned earlier, the best way to invest in the S&P 500 is with a single purchase. There is no longer a need to buy each stock individually to recreate an S&P 500 portfolio on your own, but you do have some options on how and where to make your one purchase.
1. Index Funds vs Exchange Traded Fund
First, you need to decide if you want to invest in an index fund or exchange traded fund (ETF). Below are the high-level differences between the two:
- Trade once at the end of a day
- No transaction fee to purchase (when buying directly from the fund provider)
- No bid-ask spread
- Trade throughout the day
- Sometimes a transaction fee to purchase (depending on which broker you purchase through)
- Has a bid-ask spread (although these are usually very, very low if buying a reputable ETF)
Ultimately, this first step is a pretty easy decision to make. Both of the investment vehicles above are similar, and you can’t go wrong with either option.
It’s more important to pick the right fund rather than the right type of fund, which leads us to step 2…
2. Decide Where to Invest and in Which Fund
Next, you should be looking both at where you want to invest and in which fund to invest at the same time.
It’s important to do these two tasks in parallel because it makes life easier to match which fund you invest in with the broker you choose. For example, you should invest in Vanguard funds through Vanguard and Schwab funds through Schwab, and so on.
It’s not necessary, as you can buy Vanguard funds through Schwab for example, but in my opinion, it just makes things easier. Plus, since most brokers allow you to trade in their own funds for free, it can help you avoid any potential fees.
To find the right fund, you can start by searching for an S&P 500 index fund or ETF that fits the below criteria:
- Mirrors the Right Index: This is obvious, but ensure that the fund matches the S&P 500. In general, picking broad, passively managed index funds (like ones that match the S&P 500) is a good index investing strategy. Specifically, you should avoid actively managed mutual funds.
- Low Expense Ratio: An expense ratio is the main fee associated with these funds, and should be kept to a minimum.
- No Other Fees: Transaction costs, load fees, and 12b-1 fees should all be $0.
- Minimum Investment: Ensure that the minimum investment is low enough that you can get started.
- SWPPX – Schwab S&P 500 Index Fund
- FXAIX – Fidelity 500 Index Fund
- VOO – Vanguard S&P 500 ETF
Of course, these are not your only options. If you already have a brokerage, then you should assess if they have high-quality index funds and ETFs that could fit your needs. Otherwise, you can look to open a second brokerage account.
3. Purchase Your Investment
Once you have a brokerage and fund picked, it’s time to execute the trade.
And while you could sit back and relax from here, it’s generally not recommended.
It’s good to manage your portfolio ongoing. Not that you should check on your investments every day, but checking in every month, quarter, or year to monitor performance and add additional funds is a wise choice.
Why the S&P 500 is a Good Index
The S&P 500 is a good index to match for two primary reasons:
For one, it’s a broad and diversified index of stocks. It’s a good barometer of the total US stock market and has international diversification despite not having any foreign companies in the index. That’s because many US companies do business abroad and are naturally diversified in their business practices.
In addition, the S&P 500 has a long history of generating good returns. With investing, no one can predict the future. Oftentimes we need to rely on past returns as a guide for future performance (a guide, not a guarantee). The S&P 500 has a long history of providing a positive annual return on average, despite some ups and downs.
The S&P 500 is a good option, but not your only option. Many other indexes like the Dow Jones, Russel 2000, and Nasdaq Composite are solid alternatives to explore. Plus, brokers like Vanguard and Schwab offer broad market funds that track other indices like the Dow Jones US Broad Stock Market Index.
Pros and Cons of a Single Fund Portfolio
Most single fund portfolios are made up of a broad market index fund or S&P 500 fund. Alternatively, one fund portfolios could be comprised of a blended fund that has stocks and bonds within it, like VBIAX from Vanguard.
Simplicity: Managing a one fund portfolio is about as easy as it gets and makes starting investing straightforward and simple.
Low Fees: As long as you pick a fund with a low expense ratio, you will be able to keep your investing costs very low. Plus, in most cases, you don’t need to pay a financial advisor if you are simply managing a one fund portfolio.
Good Starting Point: For beginners, starting with one fund can often be a good jumping-off point. From there, as you continue on your investing journey and grow your portfolio, you can expand to two, three, and four funds as you see fit.
Lack of Diversification: If you opt for an S&P 500 or broad stock market fund as your single fund portfolio, you will be completely exposed to the stock market without any diversification in bonds, real estate, or other asset classes.
Customization: If you invest in a blended fund, like the Vanguard one mentioned above, you will lose out on the ability to customize your allocation between stocks, bonds, and other assets. You will be at the mercy of whatever allocation the fund uses.
The Alternatives are Easy, Too: Building a two or three fund portfolio is not that much more work than a single fund portfolio. The amount of benefit you get through diversifying with a few extra funds is likely worth some extra effort.
Single Fund Portfolio Alternatives
Of course, a single fund portfolio is not your only option. In fact, it’s not even your only easy option. Building a two or three fund portfolio is also very simple and keeps costs low, but also gives you the benefit of further diversification.
If your first fund is an S&P 500 fund or broad stock market fund, below are other types of index funds and ETFs you could add to build a two, three, or four fund portfolio:
- Bond Market Fund
- International Equity Fund
- Real Estate Fund (REIT)
- Small or Mid-Cap Equity Funds
For example, a traditional three fund portfolio is made up of a US Equity Fund (like an S&P 500 fund or broad stock market fund), a bond market fund, and an international equity fund.
To determine what type of portfolio you should build, it’s often best to first understand your financial goals. Once you know your goals, you can then set an investment strategy and decide which funds will help you best accomplish your goals.
Summary: How to Invest in S&P 500
The two main takeaways from this article should be:
- Investing in the S&P 500 is a good start to building an investment portfolio
- Investing in the S&P 500 is easy, thanks to index funds.
Whether you want to build a single fund portfolio or invest in the S&P 500 as part of a broader investment strategy, you can do so in just three steps:
- Decide on the type of fund to invest in
- Pick a fund and a broker
- Invest and monitor ongoing
Remember, while this index is a good one, it’s not your only option when it comes to investing in broad, US Stock index funds. There are a lot of other broad indexes that are good investment options. Just ensure that they are low cost and fit your investment goals.