A couple of years ago, Warren Buffett revealed just how much he likes index funds. In an interview on CNBC, the legendary investor said that when he dies, he has instructed the trustee of his estate to invest 90% of the money he leaves to his wife in an S&P 500 fund.
That's a sensible plan. The S&P 500 is a collection of most of America's largest companies, and most of the funds that track it are automatically rebalanced and charge very low fees.
Now, Buffett's widow will be quite wealthy even before most of her assets are shifted into index funds. But are the gains an S&P 500 fund can deliver enough to make you into a millionaire by the time you retire?
That question is best answered in two parts: First, is such a fund all you need? And second, is it the optimal choice for you? Regardless of where your answers fall, it's easy to make the case that an S&P 500 index fund should be a core part of your portfolio.
What is "enough," anyway?
For the last 25 years, the S&P has repeatedly proven its ability to grow fairly steadily. That's not to say there weren't major bumps in the road in 2000, 2008, and 2020. However, a long-term investor would have seen robust gains over the period, especially if they reinvested their dividends, and perhaps more importantly, refrained from trading in and out of the market.
Assuming a 10% average annual return from the S&P 500 alone and a time horizon of 30 years, investing $446 each month would leave you with a portfolio worth about a million dollars. For many retirees, this would be more than enough, especially when combined with Social Security in an area with a reasonable cost of living.
If the question is whether a portfolio containing only (for example) the Vanguard S&P 500 ETF (NYSEMKT:VOO) would be enough to fund a comfortable retirement, the answer is yes. The real key, however, has more to do with the behavior of the individual than that of the index. For this to work, the prospective retiree must invest at regular intervals, set their dividends to reinvest automatically, and not attempt to time the market. If you're willing to commit to such a steady buy-and-hold strategy, it's highly likely that your portfolio at retirement will be more than enough to cover your living expenses.
So it's enough. Is it optimal?
Investing in the S&P 500 has proven a good way to grow wealth over the long term. That said, it's also important to think about what could go wrong with this strategy, and what it leaves out. Three caveats spring to mind.
First, there is no guarantee that the U.S. economy will continue to grow at the same general rates that prevailed in the 20th century and the early part of the 21st. This is a deeply divided country that has difficulty managing crises. Further, climate change stands as an existential threat that will in all likelihood impede the world's ability to advance economically as it once did.
Second, to fully commit to a buy-and-hold strategy, you need to have nerves of steel when it comes to volatility. The U.S. stock market has the ability to go up -- and a strong historical pattern of doing so -- but it can also fall precipitously at times. If watching the value of your whole portfolio drop by 30% to 50% in a single year (or month!) might cause you to panic and sell, you may want to add some conservative investments, like corporate or municipal bond funds, to help to smooth out the bumps and dips.
Third, if you're American, investing in the S&P 500 carries a home-market bias. As it turns out, there's a big world out there. Many international funds, such as Vanguard's All-World ex-U.S. Fund (NASDAQMUTFUND:VFWAX), provide exposure to overseas companies with significantly different sources of risk than domestic businesses. Adding international funds -- whether they focus on developed or emerging markets -- will diversify your portfolio even further.
A strong choice, but plan accordingly
Good financial planning strategy suggests that you maintain reasonable levels of liquidity (i.e., cash reserves) and diversify your investment risk on a global level. That said, putting a large share of your retirement nest egg into an S&P 500 index fund is a strong long-term choice, whether you're a novice investor or an experienced financial professional.