S&P 500 index is the most widely followed global indicator of the American stock market. It represents a single number that is calculated based on the market value of top American companies that trade on the NYSE or NASDAQ stock exchanges. Having a single number that represents the overall stock markets helps to keep track of how the larger, broader stock market is moving.How to Invest in the S&P 500 Index?
Since this index is widely followed, many novice traders and investors are willing to invest in the index. This article explains how they can make investments through S&P 500 index. Theoretically speaking, investing in the S&P 500 index in not possible because it is not a financial security but an index that allows us to keep track of the overall market development. However, one can still invest in the S&P 500 index by taking a trading or investment positions in associated financial securities and funds which attempt to mirror the performance of the index. Following is the list of all possible ways through which one can trade or invest in the S&P 500 index.
Direct Investment in S&P 500 Stocks
Since the S&P 500 index is made up of around 500 individual stocks, one can look at investing in all those individual stocks. The investment should be made in the stocks in the same proportion as that of the index. For example, say an investor has $10,000 to invest in the index. If Apple Inc. (AAPL) is having a weight of 4.5 percent in the index, then the investor should invest ($10,000 * 4.5%) = $450 in Apple stock. Similarly, if Microsoft Corp. (MSFT) has a weight of 3 percent, then the investor should invest $10,000 * 3% = $300 in the stock of Microsoft. Similarly, the investor should take proportionate positions in each of the S&P 500 constituent stocks.
As one can see, it is very impractical to invest in around 500 different stocks as it will not only be difficult to make such a large scale investment, but will also be a very costly and messy affair. Therefore, though this method sounds a possibility, it remains unrealistic.S&P 500 Mutual Funds
A more pragmatic approach to invest in the S&P 500 index is to take the S&P 500 mutual funds route. These mutual funds are passively or actively managed funds which do the work for common investors. They collect small amounts of money (like $100) from hundreds of thousands of investors, and pool all those sums together to create a big amount. They then invest this large-value capital in the stocks of the companies which are part of the S&P 500 index. Essentially, these index do the work that is described in the previous section (Invest in S&P 500 Stocks).Since the investments by fund house is done with a large amount of money, they save a lot on transaction charges and other operational overheads. By investing in this way, such mutual funds attempt to replicate the performance of the S&P 500 index. The fund charges a small amount of fee, called the expense ratio, from the investors for offering the services. If they simply invest the money in S&P 500 stocks in exact proportion, they are called passively managed fund as the fund manager is not using any additional research to predict or pick any exclusive winning stocks. If the mutual fund invests the money based on research by fund house which may not necessarily replicate the stock weights as in S&P 500 index, then they are called actively managed funds.
From the point of view of investors, this process is very efficient and convenient. They simply hand-over the money to the mutual fund manager who, after deducting the expense amount, invests the amount in the stocks of various S&P 500 index companies. The investor gets a specific number of mutual fund units, whose value changes every day. Say, an investor invests $10,000 in a S&P 500 index fund on January 2 when the S&P 500 index was at 2,500. On that day, the mutual fund was priced at $10 per unit, so the investor receives 250 units of the mutual fund. By January 15, say S&P 500 rises to 2,750 which is a 10 percent rise in the index compared to its value on January 2. The price of mutual fund unit will also rise by around 10 percent - that is, it will reach $11 per unit. The investor can then sell the mutual fund units to realize the nearly 10 percent profit, after deducting the expense ratio.
However, one must note that mutual funds are available at a fixed price only once per day as they are end of the day product. It is not possible to trade them in real time like a stock or ETF. They do not trade on the exchange, and the transactions are usually between the investor and the fund house through a broker or intermediary.S&P 500 Index Funds
Index funds are special kind of mutual funds which simply replicate the weights of all S&P 500 stock constituents in exact proportion. Due to this, they follow the passive investment strategy. Since they do not require any additional research or other associated costs, the expense ratio is usually lower than that of the S&P 500 mutual funds. They are also better in replicating the performance of the underlying S&P 500 index, as they attempt to mirror it precisely. However, investors must note that some variation comes into picture in the net returns owing to the expense ratio charged by index fund managers and asset management companies.
S&P 500 ETFs
Exchange-traded funds (ETF) are an attempt to fill the void between mutual funds and stocks. They allow real-time trading like a stock, and spreading the investment across several stocks like a mutual fund. Investors who may like to trade on the S&P 500 index in real-time can trade or invest through the S&P 500 ETFs. They work exactly the same as S&P 500 Index Funds, but they are listed as stocks and trade in real-time on a stock exchange. One can explore the List of S&P 500 ETFs. A lot of variety is available in S&P ETFs, including ones that allow 2-times or 3-times exposure to the returns of S&P 500 index (called leveraged ETFs), and there are inverse S&P 500 ETFs through which one can benefit from declines in S&P 500 index value. Along with offering this huge variety, the S&P 500 ETFs also come at a low expense ratio.S&P 500 Futures and Options
While derivatives that include futures and options are not everyone's cup of tea owing to their complex nature, the active and knowledgeable traders can explore taking positions in S&P 500 index-based futures and options. Such futures and options are available for trading on leading stock exchanges like the CME Group, and they allow taking various directional positions in S&P 500 index. One should note that these derivative instruments come with an expiry date, and they cannot be held for long periods. Trading in such instruments may require keeping a high value amount in the form of margin money, and only experienced and knowledgeable investors should try investing and trading the S&P 500 index through the futures and options.In summary, the following investment methods and securities are available to invest in S&P 500 index, and gain exposure to it:
| S&P 500 Investment | Trading Medium | Expenses |
|---|
| S&P 500 Stocks | Through brokers | Very High
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| S&P 500 Mutual Funds | Through intermediaries or directly | Moderate
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| S&P 500 Index Funds | Through intermediaries or directly | Low
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| S&P 500 ETFs | Through brokers or directly | Low
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| S&P 500 Futures and Options | Through brokers | Very High
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