Like many people, I am investing money for my future. But it may come as a surprise to know that I've intentionally chosen an investment strategy that limits the potential returns I can earn.
If things go as planned, I should earn around an average 10% annual return over many years. And it is extremely unlikely, and perhaps even impossible, that I will be able to beat this estimate by much.
This average annual return is far below what some people will make by investing in stocks or other assets such as cryptocurrencies or real estate. But I don't care. My investment strategy is absolutely the right one for me, even though I know I don't have any chance of my assets outperforming the stock market as a whole. Here's why.
Image source: Getty Images.
This is how I'm investing my money
The reason I can say with confidence that I will not beat the market is because the bulk of my money is invested in index funds that are designed to track the performance of the market.
I have most of my money in S&P 500 index funds, as well as in some total stock market funds. The S&P 500 is an index made up of around 500 large U.S. companies. Many people use the performance of the S&P as a barometer of how the "market" is doing. And obviously, my total stock market fund is also aimed at mimicking the performance of the entire U.S. equities market, including large, mid-sized and small companies.
Since I'm essentially invested in "the market" broadly and own a very small ownership stake in hundreds of different publicly traded companies, my returns will be determined based on the aggregate performance of all of these businesses. Even if one or dozens of them outperform expectations and their stock prices soar, this won't have a profound impact on my total returns because my ownership stake in each individual business is so small.
The reality is, the S&P 500 has produced average annual returns of 10% over many decades, and I know the most likely outcome is that I will earn around those returns myself -- especially since I'm leaving my money invested for the long term.
Why is this the right strategy for me -- and many others?
Despite the fact that I'm limiting my potential returns, I'm 100% confident that I've chosen the best approach for me, for many reasons.
For one thing, I have also limited my risk. Unless the entire U.S. economy collapses and doesn't recover, I am very unlikely to lose a lot of money with my investments. Plus, since my investments have such a long proven performance track record, my returns are unlikely to be much lower than I'm anticipating. That means I know how much I'm likely to make by investing so I can calculate how much I need to save each month to end up with my desired nest egg, and I'm unlikely to fall short. And I don't have to spend time researching investment options or tracking my portfolio -- neither of which are things I enjoy doing.
My strategy isn't right for everyone. Some people are great at picking individual stocks and can make much more money than I can. But it could be an ideal option for a lot of people who want a simple approach to investing that doesn't require a ton of financial knowledge. That's why Warren Buffett, one of the all-time greatest investors, advises index fund investing for the vast majority of people. I'll be following his advice, and I'm confident that doing so will pay off in the end.
