Are you at a loss about how to pick the best stocks? Join the club. The truth is, consistently selecting winning stocks is a challenging feat, even for seasoned investors.
It’s a high-risk game, as evidenced by the unfortunate saga of those still bagholding Gamestop (NYSE:GME) shares in 2024, long after the initial meme stock frenzy of January 2021 died down. This scenario underscores the potential downside of trying to outsmart the market based on hype.
For beginners in the investment world, there’s a far more straightforward and less risky path to stock market participation: investing in the S&P 500 Index via an exchange-traded fund (ETF). Here’s how this strategy works and proof that it beats the majority of investors.
Why invest in the S&P 500?
The S&P 500 is not just a random assortment of stocks; it’s a carefully curated group of 500 companies selected to represent the largest and most influential businesses in the United States.
This selection spans all 11 sectors of the economy, providing a comprehensive snapshot of America’s corporate landscape. Managed by a committee and based on specific rules, the S&P 500 is designed to be a barometre of the overall U.S. stock market and, by extension, the economy.
One of the key features of the S&P 500 is its market capitalization weighting. This means that the size of each company in the index is proportionate to its market capitalization (share price x shares outstanding)—ergo, the larger a company’s market value, the more weight it holds in the index.
This approach ensures that as companies grow and become more successful, their influence within the index increases. Over time, this has allowed the index to benefit from the momentum of its top-performing companies, as the most successful businesses rise to prominence within the index.
The performance of the S&P 500 is a testament to its robustness and the difficulty of outperforming it. According to the latest SPIVA (S&P Indices Versus Active) update, over the last 15 years, a staggering 92.2% of all U.S. large-cap funds have underperformed the S&P 500.
This statistic is particularly revealing, considering these funds are managed by professional investors whose sole job is to try and beat the market. If the vast majority of these professionals can’t consistently outperform the S&P 500, the challenge becomes even more daunting for the average retail investor.
My index ETF of choice
This difficulty in beating the S&P 500 underscores why it is such a popular choice for both individual and institutional investors. It offers a blend of diversification, representation of market leaders, and a proven track record of solid performance.
For the average investor, especially those who may not have the time or resources to conduct extensive stock research, investing in an S&P 500 index fund is a pragmatic, efficient way to participate in the stock market’s growth with a lower risk of underperformance.
I like BMO S&P 500 Index ETF (TSX:ZSP). This ETF tracks the index by buying and holding the required stocks in their correct proportions, saving you the hassle of manually doing it yourself.
Best of all, ZSP charges an expense ratio of just 0.09%. For $9 in annual fees on a $10,000 investment, you gain exposure to 500 leading U.S. stocks. That’s quite a bargain!
