Be warned: This column will cause a few raised eyebrows. It is not an indictment against the S&P 500. Rather, our goal is to explain what the S&P 500 is and why it exists. By reviewing the Index\u2019s history, we hope to share the challenges that exist within the actively traded mutual fund environment.<\/p>\n
A Standard and Poor\u2019s commission in the early 1920s served as the genesis for today\u2019s S&P 500. In 1957, the original S&P Index expanded to the 500 companies (not stocks) included in today\u2019s Index. The goal of the Index was to identify the companies that best represented the entire U.S. economy. The rationale was that this \u201cindex\u201d of companies would help economists determine what part of the economic cycle the U.S. happened to be in at any given time. Dr. David Blitzer, Chairman of the S&P Index Committee has noted, \u201cThe S&P 500 was never intended to be an investment vehicle.\u201d<\/p>\n
Regardless of intentions, from a performance perspective the S&P 500 is the largest tracked investment index on the planet among most money managers – FEG included. Vanguard\u2019s leader John Bogle, is credited with turning this economic tool into an actual investment. The \u201cindex\u201d concept helped simplify many investors\u2019 decisions about the companies in their 401k plans and retirement accounts.<\/p>\n
When Standard and Poor\u2019s created the index, they weren\u2019t trying to find the best companies for investment purposes. They sought to assemble a group of companies in different sectors of the economy. \u00a0The economic theory (and \u201ctheory\u201d is important) was that not all sectors would perform equally well in a normal economy. What economic theory? The rationale was that in good times, sectors such as industrials and discretionary consumer products, would do better than other sectors. Similarly, categories such as utilities and staples would perform better during tough times.\u00a0 This rationale wasn\u2019t based on companies\u2019 stock prices, but rather true earnings as tracked by taxable revenue.<\/p>\n
The only way to assemble the index as an investment was to use market capitalization.\u00a0 Simply defined, market capitalization is the number of shares outstanding for a company, multiplied by the price for one share. The 10 largest companies by market cap today represent more than 20% of the Index\u2019s entire return. That\u2019s a problem for another day.<\/p>\n
Because mutual fund rules have not really been updated since 1940, they are limited to owning no more than 10% of an individual company\u2019s stock. As money poured into both passive index and actively traded mutual funds, managers were forced to buy more of the larger companies in the S&P 500 Index. \u00a0This situation left the smaller and often fundamentally better companies behind. The S&P 500 didn\u2019t create this scenario. However, the Index certainly creates problems for investors in the current economy where selection of fundamentally sound holdings is paramount. To learn more about this topic, including potential solutions to today\u2019s challenges, visit yourlifeafterwork.com\/S&P500.<\/p>\n
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Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer.<\/em><\/p>\n","protected":false},"excerpt":{"rendered":" Be warned: This column will cause a few raised eyebrows. It is not an indictment against the S&P 500. Rather, our goal is to explain what the S&P 500 is and why it exists. By reviewing the Index\u2019s history, we hope to share the challenges that exist within the actively traded mutual fund environment. A […]<\/p>\n","protected":false},"author":4,"featured_media":3615,"comment_status":"closed","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"_mo_disable_npp":"","footnotes":""},"categories":[46],"tags":[],"class_list":["post-3614","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-investing"],"acf":[],"yoast_head":"\n