The money you work hard to set aside for retirement shouldn't just sit in cash. It's important to invest that money so it grows at a fast enough clip to outpace inflation and provide you with the buying power you need later in life.
When it comes to investing your retirement savings, you have choices. Some people opt to assemble a portfolio of hand-picked stocks, while others might opt to fall back on an S&P 500 index fund.
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If you go the latter route, don't assume you're making a mistake. Investing legend Warren Buffett has said many times over that the typical saver can do quite well by investing in an S&P 500 index fund. But is that the best option for you?
It's a matter of effort and knowledge
If you're not familiar with index funds, they're passively managed funds that aim to match the performance of the market benchmarks they're associated with. An S&P 500 index fund is designed to mimic the performance of the S&P 500 itself, which consists of the 500 largest publicly traded companies today.
The nice thing about investing in an S&P 500 index fund is that you're getting instant diversification in your portfolio. The passive nature of index funds also tends to make them available to investors without the high fees that are commonly associated with actively managed mutual funds.
If you're someone who doesn't have the time or knowledge to hand-pick a portfolio of stocks, then you may decide to fall back on an S&P 500 index fund for your retirement portfolio. And there's really nothing wrong with that.
However, if you do have some investing knowledge and you are willing to do the work, you may find that your portfolio is able to outperform the S&P 500 through the years. The result? A higher retirement plan balance.
Be honest with yourself
Some people start saving for retirement with zero investing knowledge and grow their stock-picking skills over time. As such, one thing you may want to do is begin by investing in an S&P 500 index fund, but then eventually grow your portfolio as you learn more about how to pick stocks yourself.
But at the end of the day, your approach to investing for retirement should really boil down to the work you're willing to put in. Even if you know a thing or two about hand-picking stocks, if you're not willing to keep tabs on your portfolio, an S&P 500 index fund may be a better bet. But if you're confident you'll be able to carve out the time to continuously research stocks and keep track of the ones you own, then hand-picking investments could make it possible to beat the S&P 500.
Of course, falling back on the S&P 500 could still prove to be quite rewarding. Over the past 50 years, the index has averaged an annual 10% return. This means that if you were to invest $300 a month in an S&P 500 index fund over 40 years, at that return, you'd end up with almost $1.6 million. So while it may be possible to do better with a portfolio you put together yourself, know that you're not exactly doomed if you decide you just aren't up to the task.
