Starting with a reader comment: “After reviewing the Dalbar Quantitative Analysis of Investment Behaviour report that measured average investors against the performance of the S&P 500 equity index over the last 30 years, where for every one of those years, the average investor failed to match or perform better than this index, my question really is simple. Why would anyone want to invest in anything else?”

Even though Dalbar’s 30-year results are statistically conclusive, this is a question that cannot be answered in one simple paragraph: so many subtle nuances arise, including the age-old argument relative to active versus passive investing, do-it-yourself versus live financial professional advice versus robo-advice, emotional, impulsive trading versus cold, clear logic, and perusal of investment statistical trends.

Enormous amounts of data can be corralled (and selectively will be in future articles) to discuss these various investment positions: today, a brief overview of the evolution of the S&P 500 index with references for you, dear readers, to peruse at your leisure.

More than 150 years ago, as the United States embraced continentwide railway systems, oil was discovered in remote north-western Pennsylvania, and with the New York Stock Exchange already in operations for decades, investors needed access to detailed finance and regulations knowledge. Information rom sources such as industry periodicals, newspapers and the telegraph, became critical to competitive trade decisions for the information investment world; it was timely enough for then, but not one-click Google away today.

Information is always being redefined, and detailed for greater transparency.

In 1896, finance reporter Charles Dow created the DJIA, the Dow Jones Industrial Average, the statistical performance of the 30 US mega-giant corporations, their combined value today in excess of $10 trillion.

Decades later, Poor’s Publishing Company issued its first credit rating; it was then later (1941) to merge with Standards Statistics Bureau to form the Standard & Poor’s Company. S&P Global Ratings then developed the now extraordinary (they could not have conceived of such in 1957) measurement of the stock market, the S&P 500 Index, an enhanced ancillary service to their global credit rating services for companies and countries.

Today, the S&P 500 equity index exerts massive global influence as a premier financial benchmark and is also an integral component of investment allocations as an actual investment product.

Who are these 500 companies?

The S&P 500 represents a broad cross-section of important industries of the US equity market. Many are household names: Amazon, Alphabet, Apple, Johnson & Johnson and Microsoft, but broad popular familiarity is not a requirement as lesser-known companies meeting the index criteria are included.

Companies are further allocated into 11 sectors: energy, materials, industrials, consumer discretionary, consumer staples, healthcare, financials, information technology, communication services, real estate and utilities.

The largest companies in the S&P 500 account form a substantial portion of its total market capitalisation. Since the index is market-capitalisation weighted, these companies have the greatest influence on the index’s price performance.

How is the make-up of the S&P 500 determined?

Being classified a member of the S&P 500 is prestigious, but also brings increased scrutiny and accountability. Here is a broad overview of the requirements listed in the 50-page S&P US Indices Methodology May 2022

• Only common stocks of a US publicly traded corporation

• Primary listing must be on an eligible US exchange

• Meet the market capitalisation requirements

• Company must be highly liquid

• Have a public float of at least 10 per cent of its shares outstanding

• Positive earnings for most recent quarter and

• Positive earnings for the sum of its trailing four consecutive quarters

Companies are chosen by the US Index Committee, as are companies that are deleted that no longer meet the eligibility requirements through restructuring, criteria violation or related matters – all in strict confidentiality due to the potential to influence markets.

Generally turnover in the index itself is estimated at about 4.4 per cent (or 22 companies) each year, either added or removed – giving rise to a question as to whether an S&P 500 Index fund is truly passive.

How has it survived all these years?

Very well – according to numerous calculations of the average annualised return since its inception in 1957 through December 31, 2021, assuming reinvestment of dividends, is 10.67 per cent.

$100 invested in 1987, returned 10.44 per cent and would have grown to well over $3,000 – see the chart!

Now more than 65 years later, the index continues to track the performance of the 500 eligible United States companies’ stocks, lists a total market cap of $36.7 trillion, yes trillion!

So, to our reader question.

“Why would anyone want to invest in anything else?”

The S&P 500 Index Funds are offered by many investment firms, brokerages, and financial institutions.

Investing in the fund is considered a passive, also described as a buy and hold, strategy to maximise returns by minimising the decisions to buy and sell while holding for a long period of time

Even passive investing is difficult for some investors.

It becomes very difficult to control emotional behaviour when markets are in chaotic volatility. The S&P 500 Index has had down years but has always recovered – over the long time frame. Patience, confidence in the decades-long track record of this index and its underlying funds, can be practised.

One lasting observation that I’ve quoted over the years when investor emotions and sheer fear of unrealised losses overrides regular logical thinking, is this.

Just looking at the S&P 500 index, or other indexes, or even single securities, ask two questions:

Is every one of these companies going out of business?

Has US capital markets recovered after every crash?

Common sense says “no” to the first question and “yes” to the second.

Finally, Dalbar has significantly more information on investor behaviour, portfolio allocations, and lifestyle financial management that can help manage investor emotions. More on that in future articles.

References

“How buy-and-hold compares to average fund investor”, Martha Myron, The Royal Gazette, May 23, 2022

S&P Global Indices, https://tinyurl.com/2bjbwcds

List of S&P 500 companies as at June 2, 2022, https://tinyurl.com/29dlxdeo

S&P US Indices Methodology, https://tinyurl.com/227kjxrj

• Martha Harris Myron is a native Bermudian finance columnist and author of Bermuda’s First Financial Literacy Primer: The Dawn of New Beginnings