The $1 million mark is a huge financial milestone for most people. There's something about it that just feels like... success. (Not that I would know personally.) And although $1 million has long been a token of financial success, it's becoming a baseline for many people's retirement plans.
Saving $500 monthly and putting it in a no-interest bank account, it would take 166 years and eight months to reach $1 million. Luckily, investing and the power of compounding can help you hit the $1 million mark in a fraction of that time. However, the best part is that it can likely be achieved with an S&P 500 exchange-traded fund (ETF) like the Vanguard S&P 500 ETF (VOO 1.00%).
Why the S&P 500 is a smart choice for investors
The S&P 500 is an index that tracks the 500 largest public U.S. companies. It serves as the benchmark for the U.S. stock market, with most funds and indexes judging their performance relative to the S&P 500's performance. It's also a one-stop shop for investors.
It has lots of diversification, containing large-cap companies from all major sectors. The large amount of ground it covers reduces the risks of having a portfolio that's too concentrated in a particular company or sector. It also promotes long-term growth because you have sectors that can pick up the slack when more cyclical sectors have their downturns.
Since its expansion to 500 companies in 1957, the S&P has averaged around 10% annual returns for investors who hold on to it long-term. Since its September 2010 inception, the Vanguard S&P 500 ETF has averaged over 13% annual total returns. Past results don't guarantee future results, but they do give a good indication of the consistency and reliability of the S&P 500.
There are a handful of S&P 500 ETFs, but my go-to is the Vanguard S&P 500 ETF because of its low 0.03% expense ratio. That's much cheaper than the popular SPDR S&P 500 ETF Trust's 0.0945% expense ratio, and there isn't much tangible difference between them since they both mirror the S&P 500 index.
It all comes down to time and compounding
Compounding happens when the money you've made on investments earns money on itself. For example, if you earn $100 in interest and reinvest it, that $100 now begins to earn interest. Then, that interest earns interest. Rinse and repeat.
To see the power of compounding in action, let's look at the total value of $500 monthly investments over different spans, assuming they average 10% annual returns.
| Years Invested | Total Value | Amount of Capital Gains |
|---|---|---|
| 20 | $343,600 | $223,600 |
| 25 | $590,000 | $440,000 |
| 30 | $986,900 | $806,900 |
| 35 | $1.62 million | $1.41 million |
| 40 | $2.65 million | $2.41 million |
Source: Author calculations. Numbers rounded down to the nearest hundred.
Looking at the capital gains, you can see that the amount personally invested in each scenario is far less than the total value. That's the work of compound earnings.
To get the most out of compounding, you need time. Time is to compounding what fuel is to engines; without it, it doesn't start. The longer you give your investments, the more of the heavy lifting it can do.
There's an easy way to save thousands in taxes
A Roth IRA is a retirement account that lets you contribute after-tax money and then take tax-free withdrawals in retirement. One of the best qualities of a Roth IRA is that it's essentially a brokerage account with a huge tax break. If you're eligible, you should invest in the Vanguard S&P 500 ETF in a Roth IRA before doing so in a brokerage account.
The current capital gains tax rates are 0%, 15%, and 20%. Assuming someone falls into the 15% or 20% range, here's how much could be saved in taxes by using a Roth IRA:
| Capital Gains | Amount Saved at 15% | Amount Saved at 20% |
|---|---|---|
| $223,600 | $33,540 | $44,720 |
| $440,000 | $66,000 | $88,000 |
| $806,900 | $121,035 | $161,380 |
| $1.41 million | $211,500 | $282,000 |
| $2.41 million | $361,500 | $482,000 |
Source: Author calculations.
If you're going to be investing in the Vanguard S&P 500 ETF (or any other stock), it helps to use a Roth IRA and take advantage of having your investments grow and compound without a tax bill waiting for you down the road.
Consistency and the power of the Vanguard S&P 500 ETF can make the million-dollar mark realistic, and a Roth IRA can help you keep a lot of that money in your pocket instead of Uncle Sam's.
