An S&P® ETF is an investment vehicle similar to a mutual fund that can be traded like a stock. It tracks the performance of the largest companies based in the United States. Such a fund is correlated to The Standard & Poor's 500®, which is an index that tracks the top 500 stocks in the US in terms of market capitalization. Investors gain exposure to some of the country's most powerful companies through an S&P® ETF at a small percentage of what it would cost to invest in those companies individually. The price of the fund is based on market factors rather than the net asset value of the included stocks.
Portfolio diversification is a goal of many investors, and exchange-traded funds, or ETF's, are financial instruments that allow them to achieve this goal. The value of an ETF tied to a specific index is based on the performance of the stocks within that index. In the case of an S&P® ETF, the fund invests in only the cream of the crop of American companies. Investors can buy and sell the fund with flexibility that a typical mutual fund, which also pools investment capital from multiple sources, cannot provide.
The stocks included in an S&P® ETF are based on an index known as The Standard & Poor's 500®. Standard & Poor's®, a financial services country, tracks the performance of the top 500 stocks in the U.S. market to calculate this index. Stocks are ranked in terms of their market capitalization, which is the amount of shares investors own of a stock multiplied by its current market price. Any or all of the stocks included in the S&P 500® can be included in an ETF fund devoted to the index.
For example, some funds base the stocks they include on certain sectors of the market. Another type of S&P® ETF may select certain stocks out of the Top 500 for fund inclusion based on the fund manager's analysis of their future prospects. Other funds can be directly tied to the S&P 500® index itself, which averages out the prices of all 500 stocks.
It is important for investors to note that the price of an S&P® ETF is determined in the same way as if it were a stock. Whereas other mutual funds are priced based on the value of all of the assets included, also known as the net asset value, an ETF derives its value from the action of investors. If more investors are buying into the fund than selling it, the price will go up. It will drop if more investors sell than buy.