If you’re an investor seeking quick diversification and predictable returns, you can begin investing in the S&P 500 in a few easy steps. First, you need to understand what you’re buying, open an account, pick a fund, and then make your first purchase. Lastly, it’s essential to regularly monitor your portfolio for vital signs that may affect your future investment decisions.
How To Invest in the S&P 500 in Six Steps
Understand what the S&P 500 is and what investments it is comprised ofConsider the pros and cons of purchasing an S&P 500 index fund and determine whether it fits your investment objectivesOpen an investment account with a reputable investment company or brokerageChoose which fund you wish to purchaseMake your first investment transactionRegularly monitor and manage your portfolio after being invested
What You Need To Know Before You Invest in the S&P 500
There are a few things you should know before investing in any fund that tracks the S&P 500. First and foremost, you should know what the S&P 500 is and what it’s not, what it’s composed of, and understand potential risks associated. A market index tracks the performance of a basket of stocks that represent a particular market or sector. It’s probably near impossible to recreate the entire index by investing in all the stocks individually, using the same weights. But there is a simpler way to get exposure to the S&P 500. Investment companies like Vanguard create mutual funds and exchange-traded funds (ETFs) that track the S&P 500 index. Investing in one of these funds is equivalent to investing in the S&P 500 index. Investors of all skill levels and experience levels invest in the S&P 500 for many reasons, including:
Diversification: Purchasing a fund that tracks the S&P 500 automatically diversifies your money amongst 500 of the largest publicly-traded companies in the US.Passive Investing: Those who wish to be “passive investors” can do so by putting their money in index funds like the S&P 500.Predictable Results: The earliest iteration of the S&P 500 has been around since 1923. As of Sept. 30, 2021, the 10-year annualized return for the index has been 16.63%.
Understand the Risks of Investing in the S&P 500
Investors should always be aware of common risks before investing in the S&P 500 index. Some include market risk, investment style risk, management risk, tracking errors, and underperformance risks.
Stock market risk: There are no guarantees when you invest in the stock market. Stock market risk refers to the chance that stock prices may decline, resulting in a potential loss.Investment-style risk: The S&P 500 is composed of large-capitalization stocks. Investment style risk refers to the risk that returns from these large-cap stocks could be lower than the overall stock market returns.Tracking errors: This risk refers to the index fund not tracking the investments in the underlying index perfectly. If an index is updated, the fund has to update as well to track the index correctly.Underperformance: Any fees, expenses, trading costs, and tracking errors could result in the fund underperforming the actual performance of the index itself.
Pros and Cons of Investing in the S&P 500
Pros Explained
Well diversified among stocks: When buying an index fund that tracks the S&P 500, you are essentially splitting up your money amongst 500 of the largest companies in the US. Suffice it to say that you are well diversified amongst publicly traded companies in the US. Dividend payouts: Many companies in the S&P 500 index pay dividends to their shareholders. As an investor in a fund that tracks the index, you will receive dividends relative to the amount invested. Little management required: Investing in the S&P 500 index requires little management because the fund’s objective is to simply track the corresponding index. Thus, people who wish to be passive investors can put their money in the index fund and let it sit without much worry about actively managing their investments.
Cons Explained
Lack of investment diversification: While investing in the S&P 500 does give you diversification among equity investments in the U.S., it doesn’t diversify you among different types of investments, nor does it diversify you geographically because all the companies are listed in the US.Lack of flexibility: Index funds such as this don’t have active fund managers that can react to market movements or economic events and make changes to the investments accordingly. No exposure to small-cap stocks: The S&P 500 requires that all included companies have at least an $13.1 billion market cap. This requirement means there is no exposure to small-cap stocks.
How To Start Investing In The S&P 500
Investing in the S&P 500 is much easier than you may think. First, you need a brokerage account, then you need to decide which fund you want to buy, and lastly, you need to make your first purchase of that fund! Here’s how it works.
Open an Account
You can open up an investment account with a modern investing app like Robinhood, or you can open an account with a traditional discount brokerage firm like Fidelity or TD Ameritrade. Here’s the info you will need in most cases to open up an investment account:
Contact Info: Your name, social security number (or tax ID), and contact informationIdentification: A primary source of identification such as your driver’s license, passport, or government-issued IDEmployment: Your employment status and occupation, annual income, and approximate net worthObjectives: Your investment objectives and risk tolerance (this is usually done through a quick questionnaire)
Decide Which S&P 500 Fund To Buy
There are mainly two different types of funds you can purchase that will track the S&P 500 index. They are exchange-traded funds (ETFs) and mutual funds. So first you need to decide which type of fund you wish to buy. An ETF is a basket of companies pooled into one fund, and shares trade daily amongst individual investors, like buying and selling individual stocks. A mutual fund is a basket of investments managed either actively or passively by an investment company. Investors purchase shares of mutual funds directly from the company rather than individual investors. After deciding whether you will buy an ETF or a mutual fund, you need to choose which company to buy the fund from. There are hundreds of companies that offer S&P 500 index funds. Below is a list of companies that offer both ETFs and mutual funds with strong reputations:
What To Watch Out for After You Invest in the S&P 500
After investing in an index fund that tracks the S&P 500, it’s essential to understand that patience is your best friend. Having too high expectations in regards to your expected returns can cause you to sell your shares too quickly, resulting in a net loss or a smaller overall gain. Keep in mind that the U.S. stock market has always recovered from any economic downturns to surpass its previous highs reaching new market records. With that said, investing in the S&P 500 is not a set it and forget it approach. While it may be a more passive way of investing by nature, it’s still important to keep an eye on your investments to make strategic decisions based on your investment objectives.
Should I Invest in the S&P 500?
Investors of all experience levels purchase funds that track the S&P 500 as great additions to their portfolios. Whether you should invest in the S&P 500 or not is entirely dependent on your overall investment objective. Are you a passive investor or an active investor? What is your risk tolerance? How long will your money be invested before you need it? These are questions that will help you decide whether investing in the S&P 500 is right for you. Be sure to consult with a financial professional to make the best decision for your money.
