20. Index Funds Part 2
Posted on January 5, 2019
Today’s Letter from Grandma Sylvia
In my last letter I mentioned three indexes: the Standard &Poor’s 500, the DOW Jones Industrial Average, and the NASDAQ composite. Today I’ll give more details on the Standard &Poor’s 500 (S&P 500) to show how an index works.
The S&P 500 index contains stocks from 500 large US companies and some non-US companies (actually 505 companies total).1 Companies are selected by a committee that looks at factors such as the company size, the length of time the stock has been publicly traded, etc. From time-to-time some companies might be added and others removed.
To be included, a company must be larger than $6.1 billion in US dollars. That is, its market capitalization must be larger than $6.1 billion in US dollars. Market capitalization is defined as the sum of a corporation’s stock, long-term debt, and retained earnings2.
The S&P 500 index is a cap-weighted index, which means the largest companies are represented by a larger percent than the smaller companies.
Here are the top 10 companies in the index1:
- Berkshire Hathaway, Class B
- Facebook, Class A
- Johnson & Johnson
- JP Morgan Chase
- Alphabet, Class C
- Alphabet, Class A
- Exxon Mobil
The first three companies account for almost 10% of the index. As I looked through the list of the remaining companies, I recognized many of them and I think most readers would. Reference 3 at the end of the notes contains all the companies in the index.
The many S&P 500 index funds use the S&P 500 index as the source for the stocks in the fund.
Investors don’t buy the index, but buy funds that mirror the index. There are more than 50 such funds according to Consumer Reports. All the funds have identical sets of stocks, but total returns, expenses and other factors vary.3
Four popular S&P 500 index funds with their expenses are:
1–Vanguard S&P 500 Index Fund, VFIAX, 0.04%
2–Schwab S&P 500 Index Fund , SWPPX , 0.02%
3–Fidelity 500 Index Fund , FXAIX , 0.02%
4–T. Rowe Price Equity Index 500 Fund , PREIX, 0.23%
Vanguard pioneered low-cost index funds and, over the course of several years, now more brokerage firms have lowered their expenses. It is clear from the four funds shown here how the expenses vary. Investors would need to check the returns of the funds and other aspects of the companies before making their choices.
To repeat, the S& P 500 index is weighted, so the bigger companies constitute a larger share of the total. In contrast, there is another S&P 500 index that is an equal-weight S&P 500 index(ticker RSP) and all the companies have the same value.
The interested reader can look online for more information about the many indexes and the funds based on them.
♦ When you buy one of these S&P 500 index funds you are buying into 505 companies.
Maybe I’ll go to see a movie today and just enjoy! Wish you were here.