Question of the Day: What is the S&P500?

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Oct 14, 2014
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Question of the Day, Index Funds, Investing, Mutual Funds, Stocks

I think in answering this question, you can introduce your student to several key investing concepts:

  • How stock market indices work
  • Diversification
  • Concept of a market return
  • Passive investing (vs. active investing)
  • Importance of various industries relative to the overall economy

This can be a challenging concept to get across to students.  I love this visual representation of the S&P500, which in one picture shows all component companies in the index and how the company’s stock price has performed over the past 12 months.

Here is how to orient your students as they look at this chart:

  • Size of the box represents market capitalization (see definition below).  For example, in the Money Center Banks, Bank of America (BAC), JP Morgan Chase (JPM) and Wells Fargo (WFC) are the largest companies.
  • Color shows direction of stock price for the past year (darker green is more positive, darker red is more negative).  Over the past year, the S&P500 has had approximately a 13% return so you can see how stocks performed relative to the “market.”  This provides a great visual representation of the value of diversification.  Given the challenge in predicting which companies/industries will perform best (see this post on predictions), better to buy an index such as the S&P500 then to guess which companies will outperform.  Even in a year of strong market performance, there are still many companies in red in which investors would have lost money.  For example, if your friend recommended that you should buy stock in GameStop (ticker GME) a year ago,  your investment would have dropped 25%.
  • The 2-4 letters are the ticker symbols for companies.  If you want to know company name that corresponds to ticker, you can type into Yahoo Finance.
  • You get a sense of the importance of various industries in the economy and the relative level of competitiveness in the industry.  For example in application software, Microsoft (MSFT) and Oracle (ORCL) are clearly the largest players in this sector.

Ask your students what else they notice.  Here are a few:

  • Large dispersion of returns among companies, even those within the same industry.  For example, in Technology, Google’s stock price declined 4.52% while Apple rose over 44%.
  • Independent Oil & Gas appears to be the worst performing industry over the past year.
  • Buying an index like the S&P500 will provide you with an average market return.  Some stocks will perform better than the index while others will perform worse.  When you invest in an index fund, you are accepting the fact that you can’t predict ahead of time which companies will outperform.

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If you want to provide some background information to your students, see the resources below.

From Wikipedia:

The S&P 500, or the Standard & Poor’s 500, is a stock market index based on the market capitalizations of 500 large companies having common stock listed on the NYSE or NASDAQ. The S&P 500 index components and their weightings are determined by S&P Dow Jones Indices. It differs from other U.S. stock market indices, such as the Dow Jones Industrial Average or the Nasdaq Composite index, because of its diverse constituency and weighting methodology. It is one of the most commonly followed equity indices, and many consider it one of the best representations of the U.S. stock market, and a bellwether for the U.S. economy.[6]

What does this all mean?  Market capitalization provides investors with a measure of a company’s value and is calculated by taking the number of a company’s shares outstanding multiplied by the stock price.  For example, Apple (ticker symbol AAPL) has about 6 billion shares outstanding and a stock price of $100/share for a market cap of approximately $600 billion.  Given Apple’s large market capitalization they are more heavily weighted in the S&P500 index and make up about 2.5% of the index.

Want to get students engaged in research on the S&P500?  Ask them to find the following information through a Web Quest:

  • What are the top 10 companies in the S&P500?  What were the top 10 companies in the S&P500 in 2004?  What conclusion can you draw from the changes in the top 10 list?
  • What has been the return of the S&P500 over the past one, three and five year periods?
  • How much is invested in S&P500 index funds (hint: it’s billions of dollars)?
  • What is the top performing company in the S&P500 over the past year?  Why?
  • What is the lowest performing company in the S&P500 over the past year?  Why?

About the Author

Tim Ranzetta

Tim's saving habits started at seven when a neighbor with a broken hip gave him a dog walking job. Her recovery, which took almost a year, resulted in Tim getting to know the bank tellers quite well (and accumulating a savings account balance of over $300!). His recent entrepreneurial adventures have included driving a shredding truck, analyzing executive compensation packages for Fortune 500 companies and helping families make better college financing decisions. After volunteering in 2010 to create and teach a personal finance program at Eastside College Prep in East Palo Alto, Tim saw firsthand the impact of an engaging and activity-based curriculum, which inspired him to start a new non-profit, Next Gen Personal Finance.

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