What the S&P 500 is…and Isn’t

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© Behavior Gap

The Standard & Poor’s 500 Index is the most oft-cited index by the financial media and the most frequently used proxy for “the market” by investors – both professional and amateur.  Yet most average people don’t truly know what the index represents. They see it on their monthly brokerage statements and watch it tick up and down on CNBC, without having a good grasp on its characteristics, limitations and impact on their financial goals.

Our goal with this post is to spend a few minutes breaking down what exactly the S&P 500 index is and more importantly, what it isn’t.

 

The S&P 500 is a market-cap weighted index, meaning the returns of larger stocks within the index receive a higher weighting than those of smaller stocks.

The S&P 500 does not over or underweight stocks based on certain factors that have historically provided higher expected returns.

 

The S&P 500 includes many of the largest and most heavily traded stocks in the world.

The S&P 500 contains no allocation to small-cap stocks, which one can argue have a closer link to the underlying economy. These stocks have experienced higher long-term returns than their larger counterparts due to their riskiness.

 

The S&P 500 provides exposure to stocks of many of the most well-known and respected “brand name” companies in the United States.

The S&P 500 takes no advantage of opportunities in international stocks, which represent the majority of the global equity universe.

 

The S&P 500 is quoted by the financial media more than any other index as being a representation of “the market.”

The S&P 500 is A market – not THE market.

 

The S&P 500 is often used as a benchmark to gauge the relative performance of active U.S. Large Cap stock fund managers.

The S&P 500 is not an appropriate benchmark for a globally diversified portfolio.

 

The S&P 500 fluctuates on a daily basis, sometimes dramatically, based on a number of independent variables and the actions of thousands of players, all with varying objectives and motives.

The S&P 500 has no information about your personal financial goals or your risk tolerance.

 

The S&P 500 is one of thousands of benchmarks.

The S&P 500 is not YOUR benchmark.

2 replies
  1. Mike R says:

    During a thirty year career as a financial planner I saw the profession embrace the use of relative performance as a benchmark for achieving the goals of a financial portfolio. While I understand the use and was an early adopter and proponent of this approach to performance evaluation I found over time that the use of relative performance will not provide an accurate measure of portfolio return and, more important, may contribute to decisions that are not in the best interest of the client. All of your observations are right on the mark. Clients and their advisors should be concerned with the absolute return targeted by each individual client to achieve their particular financial goals. Relative return may have a place in determining performance attribution but should be regarded with several grains of salt.

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