Investing is for everyone. For most, it's the simplest way to build wealth and achieve financial freedom. But it can be intimidating if you're just getting started. That's because:
- The professionals on TV speak in complex jargon.
- There are too many investment choices to choose from these days.
- Fear and greed can trick even experienced investors into mistakes.
That's why beginners should consider starting with an exchange-traded fund (ETF) like the Vanguard S&P 500 ETF (VOO -0.05%). Below, I'll explain what makes it a simple yet effective building block for all investors. Here is what you need to know.
The S&P 500: Simple but remarkably effective
The U.S. stock market alone has thousands of publicly traded companies. Investors follow stock market indexes to gauge the economy's or the broader stock market's performance. The S&P 500 is arguably the most famous index. It includes 500 of America's most prominent companies. While it doesn't technically represent all stocks, most people refer to the S&P 500 when discussing the stock market.
You can't invest directly in the S&P 500, which is why there are ETFs that copy it, like Vanguard's S&P 500 ETF.
Following the S&P 500 is great for beginners for two reasons. First, companies must meet multiple requirements, such as having a minimum market cap and being profitable, before being considered for the index. These requirements keep overly speculative companies out. Second, the index gives investors instant diversification across 500 companies. Index members are market-cap-weighted, so larger stocks represent more of the index. Still, it's far more diverse than picking individual stocks.
Don't assume that being beginner-friendly means the S&P 500 doesn't impress. Companies have come and gone since the S&P 500's creation in 1923, but the index has created staggering wealth. Every $100 invested in 1950 would be worth roughly $32,000 today, not including dividends.
The index changes annually, removing declining companies and adding up-and-coming ones. It always represents America's best. Since it is market-cap-weighted, the better a stock performs, the more it contributes to the index. There's an investing phrase that says you should "cut the weeds and water your flowers." The S&P 500 does precisely that.
The S&P 500 is so good that it outperforms most professional investors over the long run.
There is no free lunch
The S&P 500 simplifies investing, but it doesn't protect you from fear and greed. The index has historically generated annualized returns averaging around 8%, but year-to-year returns vary wildly. The world is a complex place, and humans are emotional creatures.
That makes the stock market susceptible to peaks (greed) and valleys (fear) that cause large fluctuations, even in the S&P 500. You can see below that the index frequently declines 10%, 20% on occasion, and even 40% or more once in a while. Investors are better off once they accept stock market volatility as the price of admission to building long-term wealth.
How to get started
First, choose which type of investment account to use, whether it's a brokerage account or an individual retirement account (IRA).
Then, create an investing schedule. You might buy shares monthly or more frequently if you steadily add new savings. The goal is to invest over time, not all at once, to protect you from bad luck. Market downturns can be great opportunities to invest at lower prices, but nobody can predict when they will happen or how much prices might fall.
It will help you deal with the volatility if you're always buying. You might even embrace the mindset that declining stock prices can be good. After all, people love paying lower prices in virtually all walks of life... except when it comes to stocks!
Finally, sit back and let time and compounding work their magic. It can be tempting to try to buy or sell stocks based on what you think the market might do, but it's almost always a bad idea.
