Taking the temperature of a patient can help you determine their state of health. You can then gather more information based on this initial finding. Stock market indexes work similarly; they give you a sense of whether the market is rising or falling and what information you should pursue to balance your portfolio. Although the Dow Jones Industrial Average (DJIA; Dow) may be the index with which most novice investors are familiar, according to Investopedia, the S&P 500 (also known as the Standard & Poor’s 500) is the most popular index used by financial professionals.
As its name suggests, the S&P 500 tracks the value of 500 corporations that have their stocks listed on either the New York Stock Exchange (NYSE) or the NASDAQ Composite. It was created by the Standard & Poor’s company as a broader alternative to the DJIA, which only tracks 30 companies.
As explained by NerdWallet, a company has to meet strict standards in order to be selected for the index; these include: a total value of outstanding shares (ie, market capitalization) of at least $8.2 billion, being based in the United States, and being structured as a corporation with the capability to offer common stock to investors.
Calculating the index is complicated, as it considers stock splits, dividends, and spinoffs while providing a float-adjusted market-cap weighted index. Basically, the calculation is determined by taking the sum of all the 500 stocks and dividing them by an index divisor, which considers the details outlined above.
Although the S&P 500 provides a strong representation of the economy, physician investors should remember that an exceptionally large or mega-cap company like Apple can sometimes skew the index, weighing its average a little too heavily toward the fate of one company. For this reason, try to refer to several economy indicators along with sector indicators to get a more complete picture of the health of the market.