Unlike the Dow Jones industrial average, the Standard and Poor's 500 stock index (S&P 500) is a value-weighted index. The S&P 500 index is usually considered the benchmark for U.S. equality performance. It represents seventy percent of all U.S. publicly traded companies. Part of the index's popularity is due to its close association with the largest mutual fund in the world, the Vanguard 500 Index Fund, and Spiders, the first exchange traded fund.
As the name suggests, the S&P 500 consists of 500 companies from a diverse range of industries. Contrary to a popular misconception, the S&P 500 is not a simple list of the largest 500 companies by market capitalization or by revenues. Rather, it is 500 of the most widely held U.S.-based common stocks, chosen by the S&P Index Committee for market size, liquidity, and sector representation. "Leading companies in leading industries" is the guiding principal for S&P 500 inclusion. A small number of international companies that are widely traded in the U.S. are included, but the Index Committee has announced that only U.S.-based companies will be added in the future.
The S&P 500 is a relatively reliable index; after all, it represents approximately 70% of the value of the U.S. equity market. The listed companies are highly diverse, spanning every relevant portion of the U.S. economy. The S&P 500 index also tends to be the default when people discuss "index funds," since index funds based on other indexes were not widely available until recently.
Although it is a reliable index, it has its weaknesses. The index is comprised primarily of U.S.-based companies. The S&P 500 also has significant liquidity requirements for its components, so some large, thinly traded companies are ineligible for inclusion. And because the index gives more weight to larger companies, it tends to reflect the price movement of a fairly small number of stocks.
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