When the market feels more like a rollercoaster than an enjoyable climb, investors should get back to the basics and focus on long-term returns. The S&P 500 Index tracks the top 500 largest American companies, and it is considered the gold standard of the stock market.
Financial experts have long counseled that by exposing your portfolio to the S&P 500, you can take advantage of the diversification and growth opportunities that come with incorporating the biggest players in the U.S. into your portfolio. Some of the biggest companies in the S&P 500 include Apple (AAPL), Amazon (AMZN), and Microsoft (MSFT). “Investing in mutual funds and ETFs allows you to diversify your portfolio, and while it’s not glamorous to talk about, it’s an investment strategy that has worked well for millions of people,” said Jennifer Weber, advisor at Weber Assets.
S&P 500 funds offer broad exposure to the economy
An array of index and mutual funds replicate the S&P 500 and offer investors a chance to invest in a basket of stocks that closely mirrors the index. Plenty of advisors like ETFs because of the low fees. “By far the easiest way to invest in the S&P 500 is an index ETF,” said David J. Haas, a financial advisor at Cereus Financial.
When investing in an ETF or fund of any kind, understand how different sectors are weighted so you can fit your investment into the overall goals of your portfolio. Most ETFs that mirror the S&P 500 are market cap weighted, which means that the bigger companies in the index, like Apple and Microsoft, are weighted more heavily in the fund. While having increased exposure to the largest companies is a great strategy for taking advantage of big business boons, keep in mind that the index is not equally diversified across the companies included, and be wary of overweighting one particular sector, like tech, too heavily.
Most of the predominant financial service companies offer S&P 500 ETFs. The Vanguard S&P 500 ETF has an expense ratio of 0.03% and its year-to-date return so far is 5.7%. State Street Global Advisors offers the largest S&P 500 ETF that has an expense ratio of 0.09% and its year-to-date returns are up 6.3%. The Charles Schwab S&P 500 ETF has an expense ratio of 0.02%, and its year-to-date return is up 6.3%.
However, another option are so-called equal-weighted funds, meaning that the fund is divided into 500 equal slices. “Not all of the 500 companies are the same size, so an equal-weighted index fund can diversify your portfolio, further giving you more exposure to small companies, and usually more exposure to value companies as well,” explained Craig Toberman, advisor at Toberman Wealth. The Invesco S&P 500 Equal Weight ETF has an expense ratio of .2%. “This adjustment in market exposure may be worth an extra 10-20 basis points in expense ratio in some cases,” Toberman added.
Another caveat to keep in mind is that you do not have to strictly be invested in an ETF or mutual fund that has the “S&P 500” trademarked name in the fund to see the benefit of being invested in these companies. Many broad funds have exposure to the same industries and often companies in the S&P 500. The Charles Schwab U.S. Broad Market ETF and Vanguard Total Stock Market Index are both examples.
To help yourself invest consistently and avoid emotion-driven investing decisions, you can practice dollar cost averaging. Dollar cost averaging is a strategy in which investors put a fixed amount of money in a fund or investment on a regular basis regardless of how the stock market is performing. By committing to adding this amount regularly, you will avoid plunging all your money in at the top of the market, and hopefully pick up some bargains if the market is down.
Pick stocks that you know
While investing in a fund is the safest and easiest way to benefit from the power of compound interest, for those who do want to pick their stocks, it's crucial to do your research. "The positives of owning individual stocks are the tax efficiency of both buying and holding an individual company," explained Clayton Bland, Chief Wealth Advisor Officer at CliftonLarsonAllen. Tax-loss harvesting is a strategy in which investors sell an investment that has lost money to offset capital gains tax on an investment that has seen gains. "The challenge with owning an individual stock, especially for people who are [novice investors], is they may not have a lot of capital to create a diversified portfolio," he added.
The same guidelines for investing in any stock go for investing in a company in the S&P 500. "For individuals who are starting out picking their stocks, you want to look at names that have a lot of information out there that you can read and opinions or then to compare your thesis to when reviewing picks," explained Brian J. Jankowski, senior investment analyst at Fort Pitt Capital Group. "So, large cap and mega cap names have a lot of analyst coverage," he added.
Investing in companies that you know also gives you the benefit of understanding their business model. Advisors emphasized that while picking out companies is a strategy many investors employ, it is by no means necessary to get investing returns, and putting your money in funds often has more consistent and lower-risk long-term outcomes.
Direct indexing is an option for experienced investors
Direct indexing is a technique in which investors buy a portfolio of individual stocks that mimic a particular index, such as the S&P 500. Vanguard, Fidelity, and Charles Schwab are a few of the firms that offer this option to investors. The advantage is that investors can save on taxes by tracking their losses and tax-loss harvesting. Yet the fees for this option are far higher than ETFs. "By not buying all the stocks in the S&P 500—but using a computer algorithm to minimize 'tracking error', this approach allows the manager to take advantage of capital losses within the portfolio regularly," explained advisor Kenneth Waltzer at KCS Wealth.
Because this approach requires so much management on the part of the investor, advisors don't recommend it for novice investors. Only consider direct indexing if you are experienced in managing investments and tax-loss harvesting.
