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.”
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.
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:
Google parent Alphabet
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.
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
Vanguard S&P 500 ETF (NYSEMKT: VOO)
iShares Core S&P 500 ETF (NYSEMKT: IVV)
SPDR S&P 500 ETF Trust (NYSEMKT: SPY)
Fidelity 500 Index Fund (NASDAQMUTFUND: FXAIX)
Schwab S&P 500 Index (NASDAQMUTFUND: SWPPX)
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
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.
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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