Have you wondered what the S&P 500 is? It’s more important than you think and we’re going to look at how you can use it as a tool to help you gauge how your portfolio is doing.
First, S&P stands for Standard and Poor’s. Standard and Poor’s is owned by McGraw Hill and is simply the company that owns and maintains the index. (An index is simply a collection. In this case, a collection of stocks) The S&P 500 has, as you would imagine, 500 stocks in it’s index. These 500 stocks represent mostly very large companies that one would consider to be the pillars of the stock market.
How do they take these 500 stocks and assign one number to them? It used to be done by weighting the stocks. The larger companies influenced the index’s movement more than the smaller companies but now it is done differently. It’s a much more complicated way called float weighted. We won’t take time to explain it as it isn’t overly important. The important thing to remember is that the index moves up and down based on the movements of the 500 stocks contained.
The S&P must stay relevant to modern times. For that reason, a committee recommends when companies should be removed or added to the index. It is important to stay relevant because the world uses the S&P as a benchmark for how the overall economy is faring.
How can you use the S&P to gauge your portfolio’s performance? Many people make the mistake of gauging their success or failure simply by looking at the percentage of decline or gain. This is incorrect. Remember that unless you’re an institutional investor responsible for billions of dollars, you aren’t leading the market. You’re being moved by it. It would not make sense for you to only look at your portfolio’s gain or decline without relating it to the larger market.
Here’s an example. If your home’s temperature were to drop to a level that felt cold, you would first look at how cold it is outside before deciding if your furnace wasn’t working right. The same holds true with investments. If the S&P 500 were to drop 3% today and your portfolio also dropped 3%, that would not be considered a poorly performing portfolio. If the S&P dropped 30% over 6 months but your portfolio only dropped 20%, you are outperforming the S&P. You shouldn’t be upset about the 20% drop. You should be happy that your portfolio is performing 10% better than the broader index. Congratulations!
For now on, keep a close eye on the S&P 500. Gauge your success or failure against this index. Remember no quick, emotional moves. Make portfolio changes gradually.