The S&P 500 Index is considered a fairly accurate snapshot of the U.S. economy since it measures the market capitalization of the nation's 500 largest corporations. In fact, the very first exchange-traded fund (ETF) created used the S&P 500 as its benchmark.

State Street Global Advisors introduced the Standard & Poor’s Depositary Receipt, better known by its arachnoid acronym, SPDR ("spider"), and traded under the symbol SPY, in 1993. It is the oldest ETF out there and remains one of the largest by any measure.

SPY has more than $400 billion in assets under management as of late-August 2023. It also spawned a whole family of State Street ETFs known as SPDR funds, each of which focuses on a particular geographic region or market sector.

But SPY has got plenty of competition for new money from investors.

How an S&P 500 ETF Works

The S&P 500 Index is, by definition, the benchmark for any S&P 500 ETF. That means the financial institution that manages the ETF buys stock in every company listed in the index, using the same weighting that the index uses. The investor's money will rise or fall with the S&P 500. It's trickier than it sounds. The ETF manager must buy or sell a dozen or so individual stocks every year to keep up with changes in that underlying index. Some of the stocks disappear as companies get bought out, and some lose their listing on the S&P 500 by failing to meet its stringent criteria. When that happens, the ETF sponsor sells off the outgoing index component, or at least removes it from the index holdings, and replaces it with the new listing selected for the S&P 500 Index.

The result is an ETF that tracks the S&P 500 close to perfection.

Big Players in S&P 500 ETFs

The S&P 500 ETF from State Street was the first ETF but by no means the last to track the S&P 500 Index.

The Vanguard S&P 500 ETF (VOO), introduced by Vanguard in 2010, has more than $304 billion in assets under management as of late-August 2023. The iShares' Core S&P 500 ETF (IVV) from BlackRock has $343 billion in assets under management as of late-August 2023. These three players dominate the market for S&P 500 Index funds.

That's a lot of money invested in the S&P 500 but there are reasons: ETFs in general are a cost-effective way to get exposure to a number of stocks. And, the S&P 500 Index as a benchmark offers instant diversification as it covers a wide range of industries and the biggest companies in every one of them.

All of the above should mean that an S&P ETF is as good as any other. But as almost anyone who has built a fortune knows, you accumulate wealth by spending less of it. That brings us to the expense ratio.

Mind the Expense Ratio

As with any investment, profit is proceeds minus expenses. And although ETFs have become popular because of their relatively low fees, there are differences among them that can add up.

State Street charges an expense ratio of 0.0945% for its SPY, which is more than triple Vanguard VOO's expense ratio of 0.03%. BlackRock's IVV also has an expense ratio of 0.03%.

That would seem to simplify the question of which S&P 500 ETF you should buy.

It's not quite that simple. Whether it’s by virtue of their size or some other factor, SPDR shares are by far the most heavily traded of any S&P 500 ETF. They trade dozens of times as frequently as do Vanguard or iShares S&P 500 ETF shares, making it easy for a prospective seller to convert their holdings to cash.

Then again, a thinly traded S&P 500 ETF still trades close to a million shares a day.

You might have to wait a few hours rather than a few minutes. Unless you have a pressing reason, there's little reason to shift your money out of iShares and into SPDR.

Moreover, even a 0.0945% expense ratio is vanishingly low. It’s easy to find mutual funds with expense ratios 20 times that number. Granted, they offer funds that require active management, as opposed to just buying the stocks in a benchmark index.

Differences Among S&P 500 ETFs

Another difference between State Street's SPDR, the Vanguard S&P 500 ETF, and the iShares' Core S&P 500 ETF (IVV) from BlackRock is something of a technicality.

SPDR is a unit investment trust. It was the first ETF to be introduced and is still bound by an antiquated legal structure that didn’t foresee the creation of myriad ETFs.

State Street must keep all the shares it purchases in-house. Vanguard and State Street are set up differently and are allowed to lend their shares to other firms and earn concomitant interest. 

How Dividends Are Paid

Like investors in any ETF that includes dividend stocks, investors in S&P 500 ETFs receive dividends. Each fund has to pay out dividends to shareholders, but there are some other options as well.

• State Street's SPDR holds the dividend payments in cash and doles them out upon distribution.
• BlackRock's iShares Core S&P 500 ETF also pays out dividends, but only a percentage based on a formula.
• Vanguard provides the option of paying out dividends or reinvesting them in ultra-low-risk investment vehicles it manages.

Other Factors in Choosing an S&P 500 Index ETF

The first is its liquidity. While S&P 500 ETFs would be considered very liquid by their nature, some might have more daily trading volume and tighter bid-ask spreads than others.

A second consideration would be the index's tracking error. Not all index ETFs precisely replicate the index. With more than 500 stocks to own, an S&P 500 index ETF may instead choose to hold only the most important or heavily-weighted stocks in the index.

This can result in the ETF returning slightly differently from the benchmark index. ETFs that do not fully replicate an index may also have a slightly different dividend yield than that of the index itself for the same reason. Investors may also want to consider an ETF's inception date to see how long it has been around. While a newer ETF does not necessarily make it worse, it will have less of a track record and less historical data with which to compare its actual performance.

Best S&P 500 ETFs to Invest in

Today, there are a large number of S&P 500 ETFs to choose from in addition to the ones highlighted here. Here are a few of the most popular S&P 500 ETFs:

• SPY: The State Street SPDR S&P 500 ETF was the original exchange-traded fund and remains one of the most liquid S&P ETFs. It is also one of the most active ETFs for options traders. It comes with a relatively high 0.0945% expense ratio.
• VOO: VOO is Vanguard's main S&P 500 ETF. Like most of Vanguard's passive index offerings, VOO has a very low 0.03% expense ratio.
• IVV: iShares' S&P 500 ETF is comparable to the Vanguard product, including that 0.03% expense ratio. (These two ETFs could potentially be used for tax-loss harvesting.)
• SPLG: In response to the lower fees offered by its competitors, State Street issued the SPDR Portfolio S&P 500 ETF (SPLG), which also carries a 0.02% expense ratio.
• SPUU & SPXL: Managed by Direxion, these are leveraged S&P 500 ETFs. SPUU is 2x leveraged and SPXL is 3x leveraged. The leverage is bullish, meaning they anticipate an upwards move in the index. If the index rises in the short term the ETF returns will be amplified by either 200% or 300%, respectively. Or, the losses will be amplified by the same amount. Leveraged ETFs have unique risk factors and should only be held for very short periods of time, such as intraday.
• SPDN & SPXS: Direxion offers these 2x (SPDN) and 3x (SPXS) leveraged ETFs. These are bearish leverages, meaning they anticipate a decline in the S&P 500. The gain or loss of these inverse ETFs will be two or three times the index returns, in the opposite direction. Again, as leveraged ETFs, there are unique risks involved, and these should only be held intraday.

The Bottom Line

For those who reject the concept of beating the market, or the work entailed to do it, investing in an S&P 500 ETF makes sense. Be patient and you’ll track the market note-for-note. Best of all, the investment firms have already performed the task of purchasing the proper amounts of each component of the S&P 500, bundling them into a unit, and making them available in small enough slivers that anyone who wants a piece can buy one. For the modest expense ratio, that’s an excellent bargain.

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