A:

The S&P 500 is a U.S.market index that gives investors an idea of the overall movement in the U.S.equity market. The value of the S&P 500 constantly changes based on the movement of 500 underlying stocks. The index is computed by weighted average market capitalization.

The first step in this methodology is to compute the market capitalization of each component in the index. This is done by taking the number of outstanding shares of each company and multiplying that number by the company's current share price , or market value. For example, if Apple Computer has roughly 830 million shares outstanding and its current market price is $53.55, the market capitalization for the company is $44.45 billion (830 million x $53.55). Next, the market capitalizations for all 500 component stocks are summed to obtain the total market capitalization of the S&P 500, as illustrated in the table below. This market capitalization number will fluctuate as the underlying share prices and outstanding share numbers change.





sp500.gif



In order to understand how the underlying stocks affect the index, the market weight (index weight) needs to be calculated. This is done by dividing the market capitalization of a company on the index by the total market capitalization of the index. For example, if Exxon Mobil's market cap is $367.05 billion and the S&P 500 market cap is $10.64 trillion, this gives Exxon a market weight of roughly 3.45% ($367.05 billion / $10.64 trillion). The larger the market weight of a company, the more impact each 1% change will have on the index. For example, if Exxon Mobil were to rise by 20% while all other companies remained unchanged, the S&P 500 would increase in value by 0.6899% (3.45% x 20%). If a similar situation were to happen to The New York Times, it would cause a much smaller, 0.0076% change to the index because of the company's smaller market weight.

(To learn more, check out Index Investing Tutorial and You Can't Judge An Index Fund By Its Cover.)



RELATED FAQS
  1. What does the S&P 500 index measure and how is it calculated?

    Learn about what exactly the S&P measures and why it's used by market participants as a tool to understand the broader stock ... Read Answer >>
  2. Weighted Average Shares Vs. Outstanding Shares

    What's the difference between weighted average shares outstanding and basic weighted average shares? Read Answer >>
  3. Why do investors use the S&P 500 as a benchmark?

    Learn about the advantages and disadvantages of using the S&P 500 as a benchmark for portfolio performance, and understand ... Read Answer >>
  4. What is the weighted average of outstanding shares? How is it calculated?

    The weighted average of outstanding shares is a calculation that incorporates any changes in the amount of outstanding shares ... Read Answer >>
Related Articles
  1. Investing

    3 Types Of Indexing For ETF Success

    ETF success relies on the index with which it's paired. Discover three index genres for tracking average market performance.
  2. Investing

    Choosing The Right ETF Index To Reach Your Goals

    The key to choosing ETFs for your portfolio is understanding how they pick stocks and making sure their investment philosophy matches yours.
  3. Investing

    Strategies For Determining The Market's True Worth

    Learn the strengths and weaknesses of passive and active management when trying to uncover the overall market's worth.
  4. Trading

    Using index futures to predict the future

    Want to know whether the stock market will open up or down? Learn about index futures and how they can help predict how the market will trade.
  5. Investing

    Smart Beta vs. Active Management: Which is Better? (BLK, SCHB)

    Learn how smart beta funds combine the advantages of both active and passive management by tracking customized indexes without capitalization weighting.
  6. Investing

    S&P 500 Index: A Performance Analysis of Long-Term Returns

    Discover how to gain insight into the returns generated by the S&P 500 Index over the long term and how this can assist your investment goals.
  7. Insights

    The ABCs Of Stock Indexes

    Indexes can track market trends, but they're not always reliable. Can you trust them?
  8. Investing

    Investigating the Effectiveness of Equal-Weight ETFs

    Investors should know the ins and outs of equally weighting stocks before considering the related ETFs.
  9. Investing

    Introduction To Fundamentally Weighted Index Investing

    If you believe the market smiles on those who focus on value, growth or income, this vehicle may be for you.
RELATED TERMS
  1. Capitalization-Weighted Index

    Capitalization-weighted index is a market index in which stocks ...
  2. Weighted

    Weighted is a description of adjustments to a figure to account ...
  3. Weighted Average

    Weighted average is an average in which each observation in the ...
  4. Equal Weight

    Equal weight is a type of classification that gives the same ...
  5. Capped Index

    Capped index is an equity index that has a limit on the weight ...
  6. Free-Float Methodology

    A free-float methodology is a system by which the market capitalization ...
Trading Center