Top fund managers consistently select individual stocks to build high-performing portfolios. While individual investors often believe they can do the same, and some actually might, the vast majority of people aren't as skilled at stock selection.
Here's where the recommendation of Warren Buffett comes into play. The Oracle of Omaha suggests the right course of action for most people is to simply invest their money in a low-cost index fund, particularly one that tracks the performance of the broad market S&P 500 index. One exchange-traded fund (ETF) of this type that comes to mind is the Vanguard S&P 500 ETF (VOO +1.23%).
Investors who choose this path and follow it consistently put themselves in a position to be rewarded over time. For example, investing just $1,000 per month in this ETF could result in a portfolio balance of $245,000 in 10 years. Here's what you need to know.
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Using history as a guide to the future
In the past decade, the Vanguard S&P 500 ETF has produced a total return of 244%, with dividends reinvested. That's a fantastic outcome, likely buoyed by huge capital inflows into passive investment options over active strategies, generally solid economic growth, and the rise of several dominant tech enterprises. That trailing 10-year gain puts its compound annual growth rate at about 13% -- well ahead of the market's long-run average of 10% annually.
For the sake of this article, let's assume that the next 10 years will resemble the last decade when it comes to returns. Of course, nothing is guaranteed, and the future is inherently unpredictable. But if you invest $1,000 per month between now and 2035 (for a total of 120 investments), you'd have around $245,000 in a decade.
This is the power of dollar-cost averaging. You might think that to succeed as an investor, you have to make decisions like a pro and try to correctly time the market. The intention of buying low, selling high, and repeating the process sounds good in theory. However, it's virtually impossible to do well on a consistent basis. That's why a dollar-cost averaging approach makes the most sense: If you add more money to your portfolio consistently at regular intervals, you can be assured that you're taking advantage of the inevitable ups and downs of the market.
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Other benefits of this winning strategy
Knowing that $1,000 per month can end up becoming $245,000 should be enough to get any investor excited about putting money to work in the stock market. There are other clear benefits to adopting this no-brainer strategy.
For one, there's a strong chance the portfolio will beat a majority of the experts. Data shows that the performances of most actively managed funds lag the S&P 500 over long stretches of time. This doesn't prevent fund managers from charging high fees that further eat away at the returns of their investors. The Vanguard S&P 500 ETF, on the other hand, has an expense ratio of just 0.03%. That's a charge of $3 a year for every $10,000 a person has invested in the fund. That's hard to beat.
Another benefit is that this is a hassle-free approach. Investors don't need fancy degrees or certifications, expert financial analysis skills, or hours of free time every week to listen to earnings calls. Putting money into the Vanguard S&P 500 ETF on a monthly basis is essentially an automatic investment allocation. It couldn't be simpler.
It instantly provides investors with broad diversification into 500 of the largest U.S. companies. The ETF has exposure to all sectors, from technology and financial services businesses to energy and utilities. It's a bet on the growth of the American economy and on the premise that it will continue doing what it has always done. This seems like a smart bet to make.
Buying $1,000 worth of the Vanguard S&P 500 ETF every month should put you on the path to building your wealth in the next decade and beyond.
