In the world of investing, few terms resonate as strongly as the S&P 500. Perhaps you've heard Warren Buffett's endorsement or a friend's recommendation about its potential. You know it’s an American investment , but you're left with questions.

So what exactly is the S&P 500, and why does it have everyone talking? Can an Australian investor like you take part in the story of American businesses in it?

In this article, we'll explore what the S&P 500 means for the Aussie investor (hint: it's not just an American affair). We’ll also examine and compare the two methods for investing in the S&P 500. Additionally, we’ll summarise the fund options available to Australian investors through platforms like Pearler.

But let's be clear—our intention is not to play favourites or proclaim the S&P 500 as the gold standard of international investment. We aim to present the facts, compare options, and provide insights you need to make your own decision. After all, the power to choose your path is the ultimate essence of personal finance.

What is the S&P 500?

Simply put, the S&P 500 is a sharemarket index that tracks the performance of the 500 largest publicly-traded companies in the United States. The global companies in this index are listed on the New York Stock Exchange, one of the biggest securities markets in the world.

Now, you might wonder why this index matters so much. Well, the S&P 500 (also known as Standard & Poor’s 500) is often regarded as a microcosm of the American economy.

The companies belonging in this index collectively account for up to about 80% of the total market capitalisation on the US sharemarket.

When you invest in the S&P 500 index, you're supporting the crème de la crème of the U.S. equities market. These are the giants of the US economy across different sectors such as technology, healthcare, finance, and consumer goods. Think Apple, Netflix, Amazon, and Visa. When the prices of their shares move, the market feels it.

Here's the catch: the S&P 500 isn't an all-inclusive list. The index only admits companies with large market capitalisations. That means mid-cap and small-cap firms don't make the cut.

Additionally, The S&P 500 is market-cap-weighted. This means that companies with large market capitalisations have a more prominent role in this grand portfolio.

But how does this information affect you?

Many everyday investors and financial professionals alike regard the S&P 500 as the North Star of where the entire US sharemarket is headed. Hence, the S&P 500 is regarded as the cornerstone for constructing a portfolio that includes US shares. Many fund options aim to mimic the index’s performance, allowing you to potentially ride the trend of the US economy.

How to invest in the S&P 500 from Australia

When looking to invest in the S&P 500 from our sunburnt shores, you'll likely stumble upon two options: exchange-traded funds (ETF) and mutual funds . While both are low-cost and diversified funds that track the performance of the S&P 500, the mechanics differ slightly.

Option 1: Index exchange-traded funds (ETFs)

ETFs are like a box of chocolates. But instead of chocolates, they contain bits of all the companies in a specific index or a sector or an industry trend. Index ETFs , in particular, quietly mirror the performance of a particular index (like the S&P 500 or ASX 200) . When you invest in an S&P 500 ETF, you're essentially investing in all the companies within that index.

Not all ETFs are the same, though. Some follow the index closely, while others ( actively managed ETFs ) take a more active approach by selecting securities that could potentially outshine the index. So, when choosing an ETF, make sure you select the option that aligns with your goals and risk profile.

Option 2: Index mutual funds

Another route is mutual funds. These come in both active and indexed varieties , but most are actively managed. In the world of active mutual funds , fund managers pick and choose individual shares, trying to outperform the index.

However, there's a passive breed called " index mutual funds " (alternately called " index funds ") that aim to mirror the performance of a specific index.

Comparing your options: Index ETF vs index mutual funds/index funds

So, which path should you choose – index ETFs or index mutual funds? It all boils down to your investment goals, cost preferences, tax considerations, and your style.

If you value simplicity and additional services like automatic contributions, index mutual funds might be for you.

On the other hand, the beauty of ETFs is that they're easy to trade on the stock exchange. It’s just like buying individual shares. You can get in and out whenever you want, giving you the flexibility to tailor your investments instantly.

Tax efficiency and cost are other crucial aspects where ETFs often shine. ETFs are designed to minimise active management fees that trigger taxable events and entail additional costs.

Just keep in mind that ETFs mirror the minute-to-minute ebb and flow of the indexes they track. So, ETFs are generally recommended for those that hold onto their investments for the long term.

Before you make your final call, don't forget to check out the fact sheet or fund prospectus for every investment. These documents give you insights into management costs, holdings, and other essential information about the fund.

What are the popular S&P 500 ETFs in Australia?

Here are three popular ETFs in Australia that passively mirror the performance of the S&P 500:

1. iShares S&P 500 ETF (ASX: IVV) : This BlackRock ETF is a relatively low-cost option for getting portfolio exposure to 500 large and established companies in the US. This fund is aimed at investors seeking long-term growth and international diversification – accessible right through the Australian Securities Exchange (ASX).
2. Vanguard S&P 500 ETF (ASX: VOO) : Vanguard manages this fund, known for its low management fee of 0.03% (the same as IVV). It's a benchmark for U.S. stock returns, available to Aussies through ASX when you open an investment account offering U.S. shares.
3. SPDR S&P 500 ETF Trust (ASX: SPY) : State Street Global Advisors oversees this fund, which remains the most actively traded S&P 500 ETF despite competition. With a slightly higher expense ratio at 0.0945%, SPY aims to keep pace with the S&P 500 index.

Now, let's talk preferences. Each of these ETFs has its own game plan, so understanding the differences is crucial.

IVV and VOO employ a passive approach, using full replication to mimic the S&P 500's moves. SPY also takes a passive stance, but it’s slightly different in terms of liquidity, daily exchange volume, and fees.

A word of caution – the sharemarket isn't all sunshine and rainbows. It can dip just as quickly as it rises, meaning your investments can lose value as well as gain it. And it’s worth keeping in mind that ETFs and mutual funds/index funds aren't guaranteed to replicate an index's performance precisely.

What you need to do before investing in the S&P 500

Choosing the right funds is only part of the equation. Knowing how to invest in them is the next critical step.

So, before you dive into the world of S&P 500 investing, here's a quick checklist:

1. Pick an index ETF or index mutual fund

Take note of the names and ticker symbols of the funds that catch your eye. You'll need these when it's time to make your move.

2. Assess your capital

Calculate the amount of capital at your disposal. This will help you gauge how much you can afford to spend on brokerage fees and commissions.

3. Choose your investment platform

To buy S&P 500 ETFs in Australia, you'll need a reliable investment platform. Options like Raiz , Stake , and Pearler are at your service. Each has its own sign-up process. However, the essentials usually include providing personal info, proving your identity, and funding your account.

4. Set up your funding procedure

Follow your chosen online broker's instructions to transfer funds from your bank to your share trading account. Some platforms, like Pearler, offer auto-investing . This feature allows you to set up recurring deposits or roundups from your daily expenses.

5. Start investing

Once your account is up and running, find the index ETF or index mutual fund you want to invest in. Then, you can place your order to buy shares/units.

Does Australia have its own version of the S&P 500?

The short answer is yes, Australia has its own version of the S&P 500. The ASX 200 is a large-cap equity benchmark that tracks the performance of the top 200 companies listed on the Australian Securities Exchange (ASX).

Every three months, the folks at S&P Dow Jones Indices do a little market housekeeping. They check whether the 200 companies listed on the ASX 200 are still the biggest players in the game based on market capitalisation. If not, they shuffle things around to keep the list fresh and reflective of the market's reality.

Potential advantages of investing in the S&P 500

Now, you might wonder how the ASX 200 stacks up against the S&P 500. They both represent around 80% of their respective market's total capitalisation and consist of the biggest and most liquid shares.

On one hand, there’s comfort in sticking to what you know. The ASX 200 feels like a cosy backyard cricket match – familiar players, familiar rules. There are also some specific benefits to investing domestically, which we won't explore in this article. However, there can also be a few potential advantages to making the S&P 500 part of your portfolio.

Diversification beyond Australian market

Say the Aussie market hits a rainy spell of below average returns. If you've diversified your portfolio internationally, some of your other investments might still be enjoying the sun. Diversifying across different markets, like investing in the S&P 500, can offer a cushion against local downturns.

Broader market exposure

The ASX 200 is heavy on financial services and basic materials—over half, actually. Now, contrast this with the S&P 500, where you’ll find more sectors like tech, healthcare, and communication services. Plus, no sector represents more than 30% of the index.

Historical growth

Historically, the S&P 500 has been posting impressive 9 to 10% annualised returns over a long period. While ASX ETFs are generous with their high dividends, they may not always capture long-term investors’ interest in capital growth.

High liquidity

Liquidity might sound like a speakeasy bar in Newtown, but it actually means how easily you can convert shares to cash. The S&P 500, with its sheer volume of transactions and global reach, makes it simpler and quicker to buy or sell shares.

Potential disadvantages of investing in the S&P 500

While the S&P 500 has its fair share of admirers, it wouldn't be a balanced discussion without looking at the less glamorous side. Every investment has its quirks, and it's essential to understand them before investing in this index.

Concentration in large-cap US companies

The S&P 500 is market-cap weighted, which means that bigger companies have a louder say in the index. While these giants are usually resilient in market downturns, it doesn't mean they're invincible. If they stumble, the whole index can shake, and so can the value of your investments.

Political and economic risks of a country

Investing solely in the S&P 500 is like hitching your wagon to the American economy and all its quirks and changes. It exposes you to risks associated with consumer spending trends and legal or regulatory changes like Federal Reserve interest rates. And if the political landscape in the U.S. changes drastically? Your investments could take a hit.

This is why many Australian long-term investors make the S&P 500 only a part of their diversified portfolio. Your S&P 500 ETF could co-exist with ASX ETFs/index funds or basket of global markets excluding the U.S.

Taxation rules

Let's not forget the taxman. When you venture into overseas investments, such as the S&P 500, you'll need to declare your overseas income. This includes realised capital gains on overseas assets such as international shares and ETFs.

Indeed, you may be eligible to claim a foreign income tax offset in Australia if you've already paid tax on that income in another country. Still, there’s something worth considering. ASX shares come with their own set of tax advantages, such as franking credits. These perks generally aren't on the table with global investments.

Exchange rate risk

For those of us outside the U.S., there's the issue of currency exchange rate risk. Fluctuations in exchange rates can affect the returns you receive in Australian dollars.

Can I invest in specific companies from the S&P 500?

When it comes to long-term investing, most investors within the Pearler Community prefer mutual funds and exchange-traded funds (ETFs). They offer diversification and can potentially reduce the stomach-churning volatility associated with individual shares. But are you missing out on something special by not hand-picking shares from the S&P 500?

There are situations where investing in individual companies from the S&P 500 might make sense from a long-term perspective:

1. Diversified portfolio first

If you already have a strong and diversified investment portfolio, some might consider allocating a portion of your capital to individual shares. This approach could work if you have strong convictions about a particular company's potential.

1. Personal enjoyment from stock picking

Should you have the time, knowledge, and desire to research and monitor shares, the allure of beating the S&P 500 might beckon. Keep in mind, though, there are no guarantees. Consistently picking winning shares can be like finding a needle in a haystack.

For a deeper discussion into this topic, check our article " Should long-term investors buy specific companies? ".

Why Warren Buffet recommends S&P 500 ETF/index funds

However, not everyone possesses the time, discipline, expertise, and tolerance for high risk needed to pick individual company shares in the S&P 500. This rings especially true for newer investors.

Warren Buffett , who knows a thing or two about making money in the sharemarket, offers advice to investors wanting to get a slice of the US economy. The legendary investor once said that a low-cost S&P 500 ETF or index fund is the best investment for most people.

Warren Buffett remarked: "I don't think most people are in a position to pick single stocks." He emphasised the importance of buying a cross-section of America and just letting it ride. After all, he firmly believes in the resilience of American businesses over the long term.

In a nutshell

The S&P 500 is a popular international investment choice that has stood the test of time. But remember, investing always comes with risks, and the S&P 500 is no exception.

For Australians eager to invest in the S&P 500, several ETFs that track it are available in Australia through investment platforms like Pearler. However, before diving in, be sure to conduct due diligence. Read through the fact sheets or prospectuses of each option to understand the nuances. Choose the one that aligns best with your investment goals and preferences.

As you gain knowledge and build a diversified portfolio, you can explore adding individual company shares. But do so with an understanding of the risks involved.

When it comes to wealth creation—simplicity, long-term outlook, diversification, and healthy money mindset are your allies. As Warren Buffett himself has demonstrated, a combination of these can lead to potential success over time.

Happy investing!