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 S&P 500 index 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 leading S&P 500 index funds 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.
