Retiring a millionaire can feel like a tall order sometimes, especially if you're new to investing. Choosing individual stocks can feel overwhelming to beginning investors, which is why many turn to exchange-traded funds (ETFs) instead.
But can they actually make you a millionaire? Below, we'll answer that question by looking at some real-life examples.
Image source: Getty Images.
How does an ETF work?
ETFs are bundles of stocks you purchase together. In this way, they're similar to mutual funds, except mutual fund trades close at the end of the day, while ETFs actively trade throughout the day like individual stocks.
Most ETFs are passively managed, which means they're designed to mimic the performance of various stock market indices. They're able to do this because they contain the same investments as their underlying index in roughly the same quantities. The stocks in the fund don't change very often, so there isn't much work for fund managers to do. That's why ETFs tend to have much lower fees than actively managed mutual funds, which are run by fund managers trying to beat the market.
A single ETF purchase can give you an ownership stake in dozens, if not hundreds, of companies. This diversification helps keep your money safe because no single stock has too much of an effect on your portfolio. When one dips, you'll probably have a few others that are doing well to pick up the slack.
There are no guarantees in investing, but this combination of low fees and a well-diversified stock bundle has historically led to strong returns.
Can investing in ETFs make you a millionaire?
As with any investment, how much you make with an ETF depends on how much you invest and how long your money remains invested before you sell. But it's definitely possible to reach $1 million with ETFs alone.
Some of the most popular ETFs are based on the S&P 500 index, which contains 500 of the largest companies in the U.S. and produces an average annual return of around 10%. There are ups and downs, of course, and some years the index actually has a negative return. But these years are rare. Over the long term, this index tends to do quite well.
If you invested $500 per month in an S&P 500 ETF that earned a 10% average annual rate of return, you'd have over $1 million by the end of 30 years. By the end of 40 years, you'd have close to $2.8 million. That's enough to afford a very comfortable retirement for most people.
It's worth noting that your actual ETF return will probably be slightly lower than the return of the index itself because of fees. But ETF fees are usually pretty low. Some of the best S&P 500 ETFs only charge expense ratios of 0.03%. That means you only pay 0.03% of what you have invested in the fund each year. For a $1 million portfolio, that's just $300 annually.
Which ETFs are right for you?
There are a bunch of great ETFs out there, and it largely comes down to what you feel most comfortable investing in. You could go with an S&P 500 ETF if you want broad market exposure, or you could focus on an ETF that tracks a sector-specific benchmark. Think about what you know best and let that guide you.
However, make sure you keep your money diversified. Investing in an ETF already goes a long way toward ensuring proper diversification, but you want to make sure you're not investing all of your money in a single sector. This could have devastating consequences if something disrupts the industry, like how the pandemic disrupted travel and dining.
Look at a few options before deciding what's best for you. Then, start by investing small sums every month just to get your feet wet. As your confidence grows, you can start investing more money and should begin to see larger returns.
