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INVESTING | Important Insight into the S&P Index

A declaration that the Standard & Poor 500 Composite Index (S&P 500) is not a collection of the 500 largest companies in America might just destroy one of the most common misconceptions about the world of Wall Street. For an economy that hangs its hat on the S&P 500 as a benchmark for $2.2 trillion in index assets alone, the workings of the S&P 500 bear a three-minute refresher.

In Simplest Terms

The S&P 500 Composite Index was introduced in 1957 by Standard & Poor’s Index Committee. It is a selection (and the word selection is important here) of large-cap stocks representing a broad array of market sectors, a few of which include technology, energy, healthcare, and consumer staples. The S&P 500 represents 80% of the value of the U.S. equity market, and it serves as a benchmark for a total $7.8 trillion in U.S. assets.

Who Makes the Cut?

The relatively narrow pool of S&P 500 companies is characterized by the following; a U.S. company, a market capitalization of $5.3 trillion or more, and a recognized leader within their industry sector. Unlike other S&P indices, however, the S&P 500 allows the Committee more discretion in selecting stocks and shifting the composition of constituent companies based on market factors.

Who Gets the Boot?

The S&P 500 is not a lifetime guarantee of inclusion or success. In fact, the average turnover rate of constituent companies hovers around 5.5%, based on the last available 2015 data. This percentage has steadily risen over time, and a recent study projects that nearly half of the current S&P 500 companies will be replaced over the course of the next 10 years.

Companies who lose their designation as an S&P 500 company typically do so as a result of a merger, acquisition, or significant restructuring, including bankruptcy.

What It All Means

Because a percentage of mutual funds and exchange-traded funds set their sails on the ups and downs of the S&P 500, they are likely to mimic changes in its makeup. Stocks of companies that exit the S&P 500 are typically sold; conversely, companies added to the S&P 500 might see a surge in stock sales. Mirroring the S&P 500 index is important to mutual funds and exchange-traded funds that prefer to track their own value in relation to the index.

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