Index funds are preferred by many, as they are easy to manage and fully diversified. The low cost and hands-free ease make them an ideal stock market investment. Passive management generates better returns on investment, and further purchasing them is more accessible.
Of the various index funds, the S&P index is a popular one because the index tracks many premium businesses in the US. Are you wondering whether investing in this index fund will bring you appreciable returns? Read on to find out everything you should know about the index so you can make good returns from it.
What Is the S&P 500 index?
S&P 500 (Standard & Poor’s 500) index is a popular name in the investment sphere and is followed extensively. It includes 500 premium US companies and is a benchmark for assessing the US stock market.
Created in 1957, companies under this index are reviewed every quarter using criteria like liquidity, market cap, etc. And, companies included here are not the largest in relation to size but their significance. At present, it includes 505 stocks, which make up about 80% of the value of the US stock market. Some of the prominent companies that feature here include Microsoft, Alphabet, Facebook, etc.
Should you invest in the S&P 500?
Over the past few decades, investments in the Standard & Poor’s 500 have brought massive returns to most of the investors. However, it is not wise to use past performance to predict future successes. There are certain considerations you need to mull over before you invest, which will ensure your investment is sound and delivers high returns. These include:
- Diversifying your investment portfolio so that you can protect your investment even if a few stocks do not perform well. And with this particular index, there is inherent diversification when you invest in the funds here. But, you can enhance diversification by using a personal account for investing.
- Market volatility consideration. Since only stocks belonging to US-based businesses are present in the S&P index, you are vulnerable to the volatility of the market in the country. Furthermore, it does not include real estate or bond investment options. So, using this as a sole investment option can land you in trouble easily. The prudent way is to use this fund as part of your investments and not the only component.
- The choice of stocks – with the S&P 500 index fund, you need not choose the stocks for your portfolio individually. While it is profitable, combining the investment with other real estate investments and bonds will further diversify and keep your risks low.
Pros and cons of investing in the S&P 500 index fund
As with any investment, there are advantages and disadvantages associated with this type of fund investment.
- Since the funds track the S&P 500, which is representative of the entire US stock market, good market performance will be profitable for your investment and vice versa. However, when looking at the past downturns in the market, and the recovery of the index, the probability of a bounce-back in the event of a severe downturn is more here.
- This is an affordable investment option ideal for people who are restricted by budget concerns. For instance, retirement investment is best made with this type of fund as the chances of growth over the long term are high here.
- With this fund type, you are investing in 500 stocks of different types simultaneously, which makes it a high-level diversification. Companies that fall under this index have more stability. Hence, they have a low level of volatility. This reduces your risk considerably.
- Investment in this fund type is not advantageous for all. Since the funds are set to follow market sentiment, it is highly improbable to outperform using this investment option. If outperforming the market is your aim, it is better to choose mutual funds that are actively managed, or another viable option would be choosing individual stocks.
- Customization of your portfolio is challenging. You will not choose the companies that you want to add or remove from the investment fund. Again, individual stocks are ideal for better customization.
How to invest in the S&P 500 index?
It is not necessary to have a dedicated financial advisor to invest in this type of fund. Opening a personal account is sufficient. For more efficiency, use a robot advisor. The fees are minimal, and some of the companies offer human support too.
One way to exploit the index benefits, while not being restricted by its limitations, is to include it as part of other funds and investments, such as foreign stocks, bonds, etc.
With robot advisors, you get the benefit of rebalancing. You can invest in an account with an option for rebalancing, so corrections are made to your portfolio in the event of market changes. So, your allocations of assets remain unaltered as the robot advisor helps in maintaining the percentage at the levels you have chosen.
Another way to minimize the drawbacks of investing is to choose the equal-weighted investment format as against the usual capital weighted format. A prominent company’s declining performance can create a big dip in the entire index in the capital-based format. This will not happen in the case of the equal-weighted system. So, all companies in the index have a similar influence on the performance of the fund.
Investing in a fund like the Standard & Poor’s 500 is a prudent choice in a wider perspective. The diversity and budget-friendly choice work in the fund’s favor. However, despite its various benefits, the fund has its risks as in any other investment option.
And although there are drawbacks, they are minor, especially if you take care to include the fund as a part of your entire investment portfolio instead of making it the sole component. Plus, for investors who are patient enough to wait through the lean years, this fund offers good long-term returns.