Why This Is My No. 1 Recommendation for New Investors

If you’re thinking of investing in stocks, good for you! There are few more effective ways to build wealth over the long run. A certain kind of investment is ideal for beginners: index funds.

Even Warren Buffett likes them, and recommends them for many, if not most, investors. In his 2013 letter to Berkshire Hathaway shareholders, he said that in his will he directs how he wants the money he leaves for his wife to be invested: “Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. (I suggest Vanguard’s.)” In a CNBC On the Money interview, Buffett noted that a low-cost S&P 500 index fund is the kind of investment “that makes the most sense practically all of the time.”

Image source: Getty Images.

Here’s a closer look at why index funds can serve you well and help you amass a lot of money for retirement or other financial goals.

Simplicity

First, index funds are simple. They’re passively managed mutual funds or exchange-traded funds (ETFs) that aim to deliver the same return of whatever index they track, less fees. S&P 500 index funds are perfect examples: They will generally hold the same stocks, in the same proportion, as the S&P 500 index does.

The S&P 500 is an index that tracks the performance of 500 of the biggest publicly traded companies in the U.S. So by plunking, say, $500 or $1,000, or $10,000 or more into an S&P 500 index fund, you’ll instantly have a stake in hundreds of companies, such as:

Apple
Microsoft
Amazon
Tesla
Google parent Alphabet
Berkshire Hathaway
UnitedHealth Group
Intuitive Surgical
Starbucks
Costco Wholesale
CVS Health
Netflix
Walt Disney
Nike
Verizon Communications

And many, many more. You don’t have to research the companies or anything — just buy shares of the index fund, and you’re invested. If you have a 401(k) plan at work, it may offer one or more index funds in its menu of investment choices. If not, you can buy into various index funds through a regular brokerage account or directly through a mutual fund company.

Low fees

Another big plus for index funds is that they tend to charge very low annual fees (often referred to as an expense ratio). While many actively managed stock mutual funds will charge 1% or more, many index funds charge less than 0.10%. Check out these examples, any of which (among others) could serve you very well:

S&P 500 Index Fund

Expense Ratio

Vanguard S&P 500 ETF (NYSEMKT: VOO)

0.03%

iShares Core S&P 500 ETF (NYSEMKT: IVV)

0.03%

SPDR S&P 500 ETF Trust (NYSEMKT: SPY)

0.095%

Fidelity 500 Index Fund (NASDAQMUTFUND: FXAIX)

0.015%

Schwab S&P 500 Index (NASDAQMUTFUND: SWPPX)

0.02%

Data source: Morningstar.com.

Solid performance

Next, index funds are likely to be better performers than you might have thought. Consider that over many decades, the overall stock market has grown by an annual average of close to 10%. Here’s how you might build wealth with annual investments of various sizes — earning a more conservative 8% average:

Growing at 8% for

$10,000 invested annually

$15,000 invested annually

$20,000 invested annually

5 years

$63,359

$95,039

$126,718

10 years

$156,455

$234,683

$312,910

15 years

$293,243

$439,865

$586,486

20 years

$494,229

$741,344

$988,458

25 years

$789,544

$1,184,316

$1,579,088

30 years

$1,223,459

$1,835,189

$2,446,918

Calculations by author.

Better still, index funds actually outperform many actively managed mutual funds. Indeed, over the 10 years ending in 2021, 83% of managed large-cap stock mutual funds underperformed the S&P 500 index, and a whopping 94% of them underperformed it over 20 years.

Variety

Finally, there’s a lot of variety in index funds. At any point, you can shake up the allocation of your money. You might add shares of other kinds of index funds, such as some that focus on smaller companies, or on international stocks, or on bonds, or whatever most interests you. There are also index funds focused on value stocks and on growth stocks, and index funds that hold the stocks in the S&P 500 but weight them differently.

Best of all, you can choose to just stick with your initial low-fee S&P 500 index fund for decades. As the table above shows, that’s more than enough to make you a millionaire over time.

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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. Selena Maranjian has positions in Alphabet (A shares), Alphabet (C shares), Amazon, Apple, Berkshire Hathaway (B shares), Costco Wholesale, Intuitive Surgical, Microsoft, Netflix, Starbucks, and Walt Disney. The Motley Fool has positions in and recommends Alphabet (A shares), Alphabet (C shares), Amazon, Apple, Berkshire Hathaway (B shares), Costco Wholesale, Intuitive Surgical, Microsoft, Netflix, Nike, Starbucks, Tesla, Vanguard S&P 500 ETF, and Walt Disney. The Motley Fool recommends CVS Health, CVS Health Corporation, UnitedHealth Group, and Verizon Communications and recommends the following options: long January 2023 $200 calls on Berkshire Hathaway (B shares), long January 2024 $145 calls on Walt Disney, long March 2023 $120 calls on Apple, short January 2023 $200 puts on Berkshire Hathaway (B shares), short January 2023 $265 calls on Berkshire Hathaway (B shares), short January 2024 $155 calls on Walt Disney, short March 2023 $130 calls on Apple, and short October 2022 $85 calls on Starbucks. The Motley Fool has a disclosure policy.

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