Why and How It Works – S&P 500


Formed in 1957 the S&P 500 index is a considered a bellwether for the US economy and stock market. It includes the largest publicly traded companies headquartered in the United States. It’s roots as an investment vehicle started when the Vanguard group created the first S&P 500 index fund in 1976. The Vanguard 500 passive index fund mirrors holdings and performance of S&P 500. It had a slow initial reception. Unlike other funds at the time, it didn’t pay broker’s commission. Today the S&P 500 index fund is among the most popular investment vehicles. This post covers how it’s changed over time, current composition and a couple reasons so many invest in it.

Changes Over Time

The S&P 500 index transforms with changes in technology and economic trends. Growing mid-size companies replace declining companies on this large-company index. In 2021 15 companies were replaced. The highest number of replacements was in 2016 with 30. This annual percentage change is called turnover. The S&P 500 index turnover is low (usually less than 5%) compared to active managed funds. But when looking long-term through the decades, you can see the changes: S&P 500 Companies – 2022 | Tableau Public

data source: The S&P 500 Historical Components & Changes | Analyzing Alpha

The growth or decline of a company’s market capitalization (price per share * number of shares outstanding) determines additions or removals. And quarterly the weighting (% of the index for each company) adjusts based on its market capitalization relative to others in the index.

See how the top 10 holdings by percentage have changed since 1980. For a visual experience, check out: Top 10 S&P 500 Companies by Market Cap (1980-2020) – YouTube


  • There has been 100% turnover in the top 10 companies from 1980 to 2020. None of the companies from 1980 remain in the top 10 today.
  • Walmart is the one company still in there from 1990.
  • Microsoft, Johnson & Johnson and Walmart are the three from 2000.
  • From as recent as 2010, there’s been 50% turnover. Only Apple, Google, Microsoft, Berkshire Hathaway and Walmart remained through the last decade.
  • Notice how Energy dominated the list in 1980 and Tech companies do today.
  • Or how about the fact that Phillip Morris was number #2 in 1990 and is now ranked #55? Did their market capitalization go up in smoke?

Why Does it Work?

Removes Investor Bias

Due to quarterly adjustments, the index mirrors how US-based companies and the sectors they represent rise and fall. We have biases towards different industries and companies. Passive index investing removes bias. For example, what if you grew up where energy is a large percentage of the local economy, like Houston, TX. And you form an investing bias towards energy that lasts throughout your life? Through the decades, that bias would have cost you return from your overweight in energy.

Below are the current top 10 holdings by weighting and sector. Check out the linked chart, you can filter by sector to see the current top holdings for each: S&P 500 stock and sector weighting (2022) | Tableau Public

source data: S&P 500 Constituents by Index Weight (2022) (finasko.com) and List of S&P 500 companies – Wikipedia

No More Chasing

When experiencing market returns from index investing, I have greater contentment with performance. And I don’t chase returns from one year to the next. For example, last year when the S&P 500 index was up 28%, I was thrilled to see that is what I saw in my portfolio. And when the index is down, you’re down. For me, it’s easier to accept “that’s just what happened in the market.” Whereas, if I try to outperform the market and come up short, my natural tendency is frustration. And then I aggressively try to outperform the market next year. Chasing returns.

By not focusing on market predictions and investment selection, you free valuable mental capacity.

The Returns are “Good Enough”

S&P 500 returns have been good enough to meet financial independence goals. The 25-year annualized return has been 9.76%. Even if future average returns are lower, given enough time, you can reach passive income levels that your cover expenses. Here’s a couple simple examples using the 4% rate of withdrawal rule of thumb. How much you need and how long it might take to get there.

There’s many variables and assumptions above. But the question I’m asking is when do you want to start your 25-30 year investing journey? The numbers are pretty exciting if you’re 20 and starting out. Less so at 40 and starting.

“May the Odds Be Ever in Your Favor”

In the next 1, 5 or 10 years I have no idea what the market will do. I do have confidence in American capitalism and the companies that we create and expand. And so, I have no reason to doubt that the next 25 years will produce similar annualized returns. This chart of S&P 500 annual returns from 1970 bolsters my confidence. Positive 42 out of 52 years (80% of the time): S&P500 returns (since 1970) | Tableau Public

data source: S&P 500 – Wikipedia

I do feel that the odds are ever in our favor as investors.


Another important factor in your financial independence journey is fees. Index funds are as close to zero expense as possible. And some providers have even made their index funds zero fee. Compare this to the average actively managed mutual fund fee. Notice the difference in cost as portfolio size increases:

source: Average Expense Ratios for Mutual Funds (thebalance.com)

If I had a portfolio of this size, I would prefer to keep the 13k either invested or receive it as monthly income.

We’ve covered the history, changes and current composition of the S&P 500. I view it as a powerful tool to consider and understand. I wish you all the best on your journey to financial independence.

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