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Investing in the US500: What to consider
This index is one of the most important benchmarks in the US economy. Each of the 500 companies within the index is allocated a different weight, based on its overall stock market cap. The selection of each component is carried out by a designated committee using strict criteria, such as a minimum market cap of $6.1 billion. The index’s price could be affected by various factors, both relating to the American economy, such as interest rate decisions and the strength of the USD, and factors relating to the companies within the composition of the index.
Who should include US500 index in their portfolios?
- Stock traders: Since it has 500 components, this index is very diversified, and could be used as a hedging tool for traders who focus on individual stocks.
- Long-term investors: Each company individually and the American economy as a whole are all geared towards generating profits and increasing their value over time. For this reason, many investors use this index as a long-term investment tool, with the hope of enjoying long-term yields.
- Commodity and currency traders: Different markets are affected by different factors. While there are trends that can affect several asset classes, it is also common for a certain asset class to show losses while another shows gains. Therefore, traders who trade financial instruments from other classes could use this index as a diversification tool, to increase portfolio stability.
- Day traders: Despite being perceived as a stable financial instrument, volatility in this index can be seen over the course of a single day, sometimes adding up to several percents. Therefore, some day traders will try to capitalise on these movements by buying and selling the US500 on the same day.
What drives the prices in this index?
It is overly complicated to break down each component of this major index and determine how each of the companies listed on the index will behave at any given time. Therefore, when looking at what drives the price of this index’s financial instrument, analysts usually consider factors that affect a group of its components or the index as a whole. These factors include:
- Market trends: This is a chicken and egg scenario, since sometimes a bullish market trend could lift the index, and sometimes, due to its massive weight, a bullish index could drive other parts of the market upwards.
- The Federal Reserve: Since interest rate decisions affect both the companies within the composition as well as investor behavior, the Fed’s monetary policy could have a tremendous impact on the index.
- Government policies: In the second half of 2017, the subject of tax reform was heavily debated in the US, until eventually, the reform came into effect, giving a major tax break to corporations. This meant that companies were now paying lower taxes and could potentially generate higher profits. As a result, many stocks went up, since investors had more faith in the profits these stocks could provide them with the lowered tax burden.
- Market data: Numerous reports are released over the course of a single year, such as the monthly Non-Farm Employment, quarterly GDP data, Price Indices and many others. Each of these reports can impact the US market and change people’s perception of it. Since this index reflects current market conditions, it could be influenced by such reports.
A bellwether of the American economy
The US has the strongest economy in the world and is home to numerous multinational corporations and giant firms. Internationally renowned companies, such as Apple, Facebook, Google and 3M are all based in the US and are all part of this index. It is no secret that corporations represent some of the most influential factors in the country and carry great significance for its prosperity and economic well-being. Moreover, since the index is comprised of various stocks, when investments pour into ETFs that track the index, they also affect the stocks themselves, since they become higher in demand.
Since the US500 index contains 500 of the largest companies, it is considered a leading indicator of the overall health and stability of the economy. For this reason, it is often used as a yardstick to measure the economic success of other investment instruments. The term ‘beat the benchmark,’ when used to describe an investment product, often refers to the fact that this specific investment instrument outperformed this index.
History of the US500 Index
While this index, initially called ‘Composite Index,’ was created in 1923, it was only in 1957 that it was expanded to include 500 companies. Using the best technologies available, the index presents real-time data and its price is constantly re-calculated throughout each trading day to reflect the value of its components. The index’s governing committee alters its composition periodically, to reflect the current market conditions to the best of their ability. For example, in the 10 years between January 1st, 2005 and January 1st, 2015, 188 components of the index were replaced. Some of the criteria for inclusion are overall market cap and stock trading volume. While initially only containing companies that were incorporated in the US, this index now contains non-US companies, as long as they are traded on one of the main stock exchanges in the US.
Conclusion: this index will remain a major part of American finance
Since the US500 is an index, it is not a tradable asset; there is no way to invest in it directly. However, various derivatives, such as ETFs and CFDs exist, enabling people to invest in the index. The US500 is a very well established part of the American financial market and is likely to stay that way.
The overall track record of the index is one of constant gains over time, which is why many investors choose to invest in investment products that track it as a long-term investment. Despite the fact that it is exposed to major market events, such as the Great Recession of 2008-2009, its diversified composition, backed by the overall strength of the American economy, will most likely help it maintain its status as a benchmark and investment opportunity.