The S&P 500 Index is in many ways the most important stock market measure we have.
After all, the landmark Dow Jones Industrial Average relies on just 30 companies, does not include Apple (NASDAQ:AAPL) and tends to lean to toward older industries like materials.
But what do you really know about the S&P 500? There is a lot of investor misunderstanding about this stock market index and how it is calculated. And some of these mistakes in perception could end up costing people real money in their portfolios if they aren’t careful.
Here are five ugly myths about the S&P 500 Index:
Myth #1: Composition
Myth: The S&P 500 is a list of the 500 largest companies in America.
The Truth: It’s actually hand-picked.
While the S&P 500 is comprised of large-cap companies, it is not as simple as sorting a list for the largest 500 companies. That kind of ranking would be difficult to follow as an index, since it would always change based on the performance and growth of individual companies. Also, a list of big dogs wouldn’t necessarily mean much for the broader market if the list was focused in just one place.
As such, the companies comprising the S&P 500 are selected by the S&P Index Committee. This group of economists, analysts and market-watchers picks big stocks that matter, but also makes sure that, collectively, the listing of 500 companies makes sense as a group. (Interested parties can read all about the methodology here.)
Myth #2: Representation
Myth: The S&P 500 is a measure of America’s economy and U.S. stocks.
The Truth: The reach of multinationals gives it a distinct global flavor.
It’s true that in the early 1990s, the S&P Index Committee decided that only U.S.-domiciled companies would be included in the index. But the largest constituents got so big because of global growth. There’s Exxon Mobil (NYSE:XOM) that drills and sells oil all over the world. There’s General Electric (NYSE:GE), which gets more than half of its revenue from overseas.
You get the picture.
While America is, of course, a big factor here, do not make the mistake of thinking you have no international exposure if you invest in an S&P indexed fund like the SPDR S&P 500 ETF (NYSE:SPY).
Myth #3: Diversification
Myth: The S&P 500 is broadly diversified.
The Truth: Tech is 20% of the index. Financials aren’t far behind.
Here’s a dose of reality for you: Apple represents almost 5% of the entire S&P 500. Exxon Mobil is another 3%.
That’s because the S&P is market cap-weighted — meaning bigger companies have bigger pull. Right now, the index is “worth” $12.7 trillion or so — and Apple’s $630 billion value and Exxon’s $400 billion value take up a lot of room in that equation.
Check out the current breakdown on the S&P website about what each sector is weighted at right now. You might be surprised that both Exxon and Apple have more pull individually than the entire market cap of constituent telecom stocks or utility stocks!
So much for not making sector bets and being diversified …