Investing in the stock market can be daunting, but with the right investments, you can generate long-term wealth while limiting your risk.
S&P 500 index funds are a fantastic option for many people. Each fund tracks the S&P 500 index itself, meaning it includes stocks from 500 of the largest and strongest companies in the U.S. By investing in just one index fund, you'll own a stake in hundreds of different stocks at once.
Image source: Getty Images.
An S&P 500 index fund is even highly recommended by legendary investor Warren Buffett, who owns this type of investment himself and often encourages other investors to own it as well.
That said, it won't be the right fit for every portfolio. Here are three reasons you may want to consider buying an S&P 500 index fund, and two reasons to avoid it entirely.
Why an S&P 500 index fund can be a great investment
1. It can limit your risk
Because each S&P 500 index fund contains hundreds of different stocks from a wide variety of industries, it offers fantastic diversification -- which is key to a healthy portfolio.
In general, the more variety you have within your portfolio, the safer your investments will be. If all your money is tied up in just a few stocks or many companies within the same industry, your portfolio could be hit hard if those stocks or industries don't perform well.
2. It's almost guaranteed to see positive long-term returns
There are never any guarantees when investing, but an S&P 500 index fund is about as close as you can get to guaranteed positive long-term returns.
In fact, analysts at Crestmont Research examined the S&P 500's rolling 20-year total returns to find out how many of those periods resulted in positive total gains. They found that in every single year examined, the S&P 500 saw positive total returns.
In other words, if you had invested in an S&P 500 index fund at any point in history and simply held it for 20 years, you'd have made money. While that doesn't guarantee future returns will also be positive, the odds are far and away in your favor.
3. It requires very little effort
One of the biggest advantages of investing in an index fund is that it requires next to no effort on your part. You don't need to choose individual stocks, and because it performs best over the long term, you also don't have to worry about when to buy or sell.
All you have to do is invest however much you can afford every month, then let the fund do all the heavy lifting. If you're looking for a low-maintenance, set-it-and-forget-it type of investment, an S&P 500 index fund may be a great fit.
Why to avoid an S&P 500 index fund
1. It doesn't allow for any customization
For those who prefer a more hands-on approach to investing, index funds may not be the best option. Because all of the stocks are automatically chosen for you, you can't customize your portfolio to fit your individual needs.
Also, if there are certain companies you'd rather not own, there's no way to opt out of investing in them when you buy an index fund. If that's a deal-breaker for you, this investment might not be the best choice.
2. It can't beat the market
Perhaps the biggest downside of an S&P 500 index fund is that it can only earn average returns. This type of investment is designed to follow the market, so it's simply not possible for it to beat the market.
For many people, lower returns are a worthwhile trade-off for the ease and simplicity of an S&P 500 index fund. But if you're willing to put in a bit more time, effort, and research, investing in individual stocks could help you earn far more over time.
An S&P 500 index fund can be a fantastic choice for many investors, but it won't be the right fit for every portfolio. By understanding the pros and cons and considering what you want out of an investment, you can decide whether it's the right option for you.
