Yahoo Finance How to Buy the S&P 500 Index With ETFs
The Standard & Poor's 500 index is the most commonly used measure of the U.S. stock market. It's far from complete, as it's primarily a large-capitalization fund, but the idea is that its components -- spread across a number of sectors and industries -- are a good indicator of the rest of the market.
But the S&P 500 serves double duty -- not just as a broader-market proxy, but also as Ahab's white whale, as it sets a bar for performance for fund managers and individual investors to reach.
The thing about setting a bar is that the second you do, you'll have people lining up to beat it. Hundreds of fund managers have plied their large-cap strategies trying to do better than the S&P 500. And the success rate is a paltry 14 percent.
An S&P Dow Jones Indices scorecard showed that 86 percent of active large-cap managers failed to beat the S&P 500 in 2014. To boot, "Nearly 89 percent of those fund managers underperformed their benchmarks over the past five years and 82 percent did the same over the last decade," CNN Money reports.
And before you start criticizing fund managers for their underperformance, understand this: By doing anything other than buying the S&P 500, individual investors are just as guilty of trying to beat that same bar. And they don't do any better.
So ... instead of trying to beat the bar, why not just buy it?
S&P 500 ETFs. You can't actually go and buy the S&P 500 itself -- it's just an index. But a number of mutual funds and exchange-traded funds allow you to essentially buy the index, holding the S&P 500's components in nearly the exact same weights.
"Buying an index such as the S&P 500 has never been easier through the use of exchange-traded funds," says David Fabian, managing partner and chief operations officer of FMD Capital Management in Irvine, California.
"The largest ETF in the world is the SPDR S&P 500 ETF (SPY), which has over $160 billion in total assets and charges an expense ratio of just 0.095 percent annually," he says. "That's an incredibly small fee to access a market-cap weighted portfolio of the 500 largest stocks in the United States."
Of course, investors have a couple more options. The other two S&P 500 trackers in the exchange-traded world are the Vanguard S&P 500 ETF (VOO) and the iShares Core S&P 500 ETF (IVV).
There are slight differences as to how the funds operate, as well as their actual costs. But if you're just trying to get familiar with S&P 500 tracking funds, here are the most important takeaways:
-- The SPY, VOO and IVV all allow you to hold the S&P 500 components within a single fund. If you buy one unit of any of these ETFs, you are exposed to the 502 stocks (thanks to dual share classes) in the S&P 500.
-- These ETFs all hold the components at nearly identical weights as they hold in the index. If Apple makes up 3.7 percent of the S&P 500, these ETFs should hold Apple at the same weight.
-- These ETFs all charge tiny expense ratios, at just a few basis points in annual fees.
In short: It's easy to hold the market.
S&P the 'weird' way. SPY, VOO and IVV are the only exchange-traded ways to buy the S&P 500 as it comes, but a few fund providers have taken the index and made a few adjustments. These are so-called "smart beta" funds, which take an index and attempt to tweak it for better performance.
For instance, the Guggenheim S&P 500 Equal Weight ETF (RSP) aims to hold all the same components of the S&P 500, but instead of weighting them according to market capitalization (the thing that makes Apple [AAPL] such a heavy influence on the index), they're weighted "equally" throughout. Which isn't to say that each stock is held at exactly the same weight, but they do have a much more even constitution, with top weighting Molson Coors (TAP) getting 0.25 percent and low-weighting Mallinckrodt Pharmaceuticals (MNK) getting 0.15 percent.
To RSP's credit, the methodology has been a success since inception in April 2003. RSP has delivered an average annual total return of 10.06 percent compared to 8.19 percent for SPY.
Still, not everyone is onboard the equal-weight train.
"An equal-weight ETF has the potential to reduce the outperformance, or alpha, of larger companies within an index," says Chris Johnson, director of research at JK Investment Group in Independence, Ohio. "For example, an equal-weighted S&P 500 ETF may show lower volatility from the equal weighting of Apple as a holding, but it would also negate the significant periods of outperformance, or alpha, that was generated by this heavily weighted stock within a market cap-weighted ETF."
And in a nod to the fact that the market simply never goes up forever, there are a few bearish funds that allow you to bet against the S&P 500. The ProShares Short S&P 500 ETF (SH) provides investors with the inverse returns of the S&P 500 on a daily basis, minus fees. So, if the S&P 500 were to drop 1 percent, SH should gain 1 percent.
The market is never enough, is it? It'd be naive to think anyone reading this would dump all their stocks, buy into the SPY and call it a day. It's simply not going to happen.
But that doesn't mean you're necessarily being irresponsible with your portfolio.
"ETFs that track the S&P 500 index can be used as core holdings within your overall portfolio," Johnson says. "This provides broad stock market correlation at an ultra-low cost and complete transparency."
Johnson actually takes this a step further, looking past large-caps as a whole. "Use of SPDR Index funds such as the SPY, MDY and SLY can help build a core of benchmark performance within a portfolio to maintain a certain degree of market performance," he says.
Put differently: Investors can put a sizable portion of their money into the S&P 500 to make sure they achieve a certain level of performance, and try to "beat the market" with the rest of their portfolio.
At least that way, if the rest of your holdings underperform, it doesn't hurt so much.
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