What are index funds?

what are index funds?

Warren Buffett instructed the executor of his estate to invest 90% of his wealth into the S&P 500 index fund for his wife after he passes. In fact, Buffett says over and over again that index funds are the best investment for regular hard working people.

So what are index funds anyway?

Well there are many index funds out there, but the most popular two are the SPY and the QQQ. 

SPY and QQQ are ETFs that follow the S&P 500 and NASDAQ indices respectively. 

Pardon? That was a lot of acronyms!

To really understand this, you’ll need to know what an ETF is. Let’s dive in…

What is an ETF?

ETFs are short for “exchange-traded funds.” These funds follow a collection of carefully selected stocks. SPY and QQQ are examples of big funds, but there are ETFs for every type of industry, index, and business sector.

For example, HACK is a collection of cyber security stocks. IWM is a collection of “small cap” companies, or companies with a market capitalization between $300 million and $2 billion. VHT is a collection of health care companies. GLD is a collection of gold miners and gold related stocks.

This way, if you want to trade or invest in specific sectors of stocks or indices, you can do that with ETFs.

What is the S&P 500?

The S&P 500 is short for the “Standard and Poors” 500. This index tracks the performance of the 500 largest companies listed on stock exchanges in the United States. The SPY ETF follows this index.

The S&P 500 has a specific value. Right now it’s hovering around $4000. SPY is modeled so that it represents a tenth of that value. So one unit (or share) of SPY is work about $400 at the moment. This makes it more affordable and easier to trade.

The top 10 holdings in SPY account for 27.37% (as of 5/13) of its total market capitalization. In order the top 10 holdings are:

1. Apple ($AAPL): 7.07%

2. Microsoft ($MSFT): 5.97%

3. Amazon ($AMZN): 2.81%

4. Alphabet (parent company of Google) ($GOOGL): 2.03%

5. Tesla ($TSLA): 1.98%

6. Alphabet (parent company of Google) ($GOOG): 1.88%

7. Berkshire Hathaway ($BRK.B): 1.69%

8. Johnson and Johnson($JNJ): 1.38% 

9. UnitedHealth Group ($UNH): 1.36%

10. Meta Platforms (formally known as Facebook) ($FB): 1.35%

As you may note, google is listed twice. That is because they have two different classes of shares that have their own tickers ($GOOGL & $GOOG) and both are a part of the top 10 major holdings in the SPY ETF.

5-Year Chart of $SPY (weekly candles)

What is the NASDAQ

The NASDAQ is actually a stock exchange itself and it is the second-highest by market capitalization of shares traded behind the NYSE (New York Stock Exchange). 

The QQQ ETF is designed to track the NASDAQ-100 which follows a basket of the largest 100 non-financial companies listed on the Nasdaq stock market. 

How much weight the stocks have in the index is based on their respective market capitalizations with caps on the influence of the largest components. 

The top 10 holdings in the ETF account for 52.22% (as of 5/13) of its total market capitalization, a much greater number than the SPY which is likely why the QQQ has its own rules on the amount the largest components can influence the ETF. 

In order the top 10 holdings of the QQQ are:

Apple ($AAPL): 13.01%

Microsoft ($MSFT): 10.63%

Amazon ($AMZN): 5.84%

Tesla ($TSLA): 4.13%

Alphabet (parent company of Google) ($GOOG): 3.92%

Alphabet (parent company of Google) ($GOOGL): 3.72%

Meta Platforms (formally known as Facebook) ($FB): 3.55%

NVIDIA (NVDA): 3.19%

PepsiCo ($PEP): 2.13%

Broadcom ($AVGO): 2.10%

5 Year chart of QQQ (weekly candles)

Important Note about some index funds

Some index funds are cash-settled. That means you don’t get assigned units or shares when trading. The SPX is an index fund that is cash-settle.

However, SPY and QQQ are “equity-settled.” You can actually buy shares of each. All ETFs are equity-settled. 

What do I do with this information?

If you want to take Warren Buffett’s advice, you could buy shares of SPY.

Use this info as a launchpad for your investing education. Find the ETFs and index funds you think will serve your investing goals best.

You can even trade options on most ETFs. If you want to learn more about trading stock options, check out our Options for Beginners series.

That’s all for now.

Happy trading,

Your fellow Stock Hackers,

🍒Cherry & Erwin

P.S. If you’re struggling to find cash flow in real estate, then this is for you: “How Real Estate Investors Find Cash Flow in the Stock Market.” This new, FREE report collects stories from 5 real estate investors and entrepreneurs about how they compliment their rental portfolio with stock hacking. Click here to get your free copy! 

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