Does the thought of picking and keeping tabs on dozens of stocks overwhelm you? You're definitely not alone. For years, I didn't trust myself to manage my own investments, because it all seemed so complicated. But now I know better and I promise, whatever your experience level with investing, there are some easy options you can use to quickly grow your retirement nest egg.
S&P 500 index funds are one great choice for investors of all backgrounds. Below, we'll look at how they work and whether they could make you a millionaire.
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What is an S&P 500 index fund?
The is a list of 500 of the largest companies in the U.S. Some of the names at the top of the list include Apple, Amazon, Netflix, and Alphabet. You'll find many more companies you recognize as well.
A market index by itself is just a tool investors use to chart the movements of the stock market. It's based on a hypothetical portfolio of investments, but index funds turn that hypothetical portfolio into a reality. They're composed of all the same investments as their underlying index in roughly the same quantities. As a result, they generate similar returns to the index itself.
The S&P 500 index has logged a compound average annual growth rate of 10.7% over the last 30 years. That means if it grew at a steady rate over that time period, it would return 10.7% for investors every year. That's better than what most actively-managed mutual funds, with investments curated by fund managers trying to beat the market, are able to deliver.
S&P 500 index funds also offer instant diversification at a low cost. Because it's essentially trying to copy the performance of the index, rather than outdo it, there's less work for fund managers to do. That translates to a lower annual fee for shareholders. Some of the charge only 0.03% per year. That means you pay only $3 annually for every $10,000 you have invested in the fund. By contrast, some actively-managed mutual funds can cost you over $100 per year for every $10,000 you have invested.
Can an S&P 500 index fund make you a millionaire?
There are four major factors that determine how much money you can make off any investment. These are:
- How much you invest
- How long the money remains invested
- The investment rate of return
- What you're paying in fees
Because the answers to those questions are going to be different for every person, it's impossible to put an exact number on how much you'll end up with. But examples can give you some idea of what to expect.
If you invested $50,000 in an S&P 500 index fund at the start of 1991, it would have been worth over $1 million by the end of 2020. Your return wouldn't match the return of the index exactly, because you'd have some fees taken out, but in the case of S&P 500 index funds, these are minimal.
As this example shows, it's definitely possible to become a millionaire investing in an S&P 500 index fund, but it's not a foregone conclusion that you will. If you invested for less than 30 years, you invested less money to start, or the S&P 500 underperformed during the time period in which you invested, you could end up with less money. Conversely, you could end up with a lot more if you invested more, held your money for longer, and enjoyed larger-than-average annual returns.
Is an S&P 500 index fund all you need to retire?
An S&P 500 index fund is definitely a smart addition to your retirement plan, and it may even house the bulk of your savings, but it shouldn't be the only thing you invest in. It consists exclusively of stocks, and while these have excellent earning potential over the long term, they can be volatile in the short term.
Investors hedge against this volatility by investing some of their money in less volatile but often lower-returning bonds. They gradually increase the percentage of their assets invested in bonds while decreasing the percentage invested in stocks. This enables them to reduce their risk of huge losses as retirement gets closer.
If you're not sure that's necessary, consider what would've happened if you'd had all your savings invested in an S&P 500 index fund and you retired in 2008 amid the Great Recession. The $50,000 we invested in 1991 in our example above would have been worth a cool $313,500 at the end of 2007, but a year later, it would have fallen below $200,000. And if you'd had more than $50,000 invested, you could have lost hundreds of thousands of dollars.
A good rule of thumb for how much you should invest in stocks is 110 minus your age. So if you're 40 years old, you'd invest about 70% of your money in stocks and the remaining 30% in bonds. Then you'd gradually move your money away from stocks until you had only 60% in stocks and 40% in bonds by the time you're 50.
It's never a good idea to place all your savings in any single investment, even one with as much appeal as an S&P 500 index fund. But if you're trying to keep your retirement portfolio as simple as possible, pairing an S&P 500 index fund with some safe government bonds can help you capitalize on the S&P 500's high growth potential without exposing yourself to too much risk.
John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Kailey Hagen has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), Amazon, Apple, and Netflix. The Motley Fool recommends the following options: long January 2022 $1,920 calls on Amazon, long March 2023 $120 calls on Apple, short January 2022 $1,940 calls on Amazon, and short March 2023 $130 calls on Apple. The Motley Fool has a disclosure policy.
As a seasoned financial expert with a deep understanding of investment strategies and market dynamics, let me assure you that the concept of utilizing S&P 500 index funds for building and growing your retirement portfolio is not just a passing trend but a well-established and prudent approach.
Firstly, the S&P 500 index, comprising 500 of the largest U.S. companies, is a robust benchmark for the overall stock market. Its performance has been consistently impressive, boasting a compound average annual growth rate of 10.7% over the last 30 years. This historical track record is not merely a statistical figure; it represents the sustained success of major companies like Apple, Amazon, Netflix, and Alphabet.
Understanding the mechanics of an S&P 500 index fund is crucial. It goes beyond being a tool for tracking market movements; it transforms the hypothetical portfolio of the index into a tangible investment reality. These funds are structured to mimic the composition of the underlying index, providing investors with returns that closely mirror the index itself. This inherent design often outperforms actively-managed mutual funds, where fund managers attempt to beat the market but often fall short.
One key advantage of S&P 500 index funds is instant diversification at a relatively low cost. The passive nature of these funds, aiming to replicate the index rather than outperform it, results in reduced workload for fund managers. Consequently, shareholders benefit from lower annual fees, some as minimal as 0.03% per year. This cost efficiency is a stark contrast to actively-managed mutual funds, which can incur significantly higher fees.
Now, let's delve into the pivotal question: Can an S&P 500 index fund make you a millionaire? The answer lies in four critical factors: the amount invested, the duration of the investment, the rate of return, and the fees paid. While exact figures vary for each individual, historical examples demonstrate the potential for substantial returns. For instance, a $50,000 investment in an S&P 500 index fund in 1991 could have grown to over $1 million by the end of 2020, even after accounting for minimal fees.
However, it's crucial to note that becoming a millionaire through S&P 500 index funds is not a guaranteed outcome. Individual circ*mstances, such as the duration of investment, initial capital, and market performance during the investment period, play significant roles. Flexibility in adapting investment strategies to varying market conditions is key to maximizing returns.
Addressing the question of whether an S&P 500 index fund is sufficient for retirement, the answer is nuanced. While it is a prudent and smart addition to a retirement plan, it should not be the sole investment. The inherent volatility of stocks, even in a diversified index, necessitates a balanced approach. Investors commonly mitigate risk by allocating some funds to less volatile but lower-returning bonds. The gradual shift towards a higher bond percentage as retirement approaches helps safeguard against market downturns.
In summary, while an S&P 500 index fund can be a cornerstone of your retirement portfolio, diversification is essential for risk management. Consider the long-term strategy of pairing an S&P 500 index fund with government bonds to capitalize on growth potential while minimizing exposure to market volatility. Remember, achieving financial goals requires a comprehensive and adaptable approach to investment planning.
