Once you retire, you'll need more than Social Security to cover your expenses. And that's why it's important to build yourself a solid nest egg.
Social Security might replace about 40% of your preretirement paycheck if you're an average earner. But it's common for retirees to need 70% of their former income or more to live comfortably. And the more savings you have, the more enjoyable a lifestyle you might have once your career comes to an end.
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It's not enough to contribute to an IRA or 401(k) and call it a day, though. It's also important to invest your retirement savings carefully, so your money grows consistently during your working years.
To that end, investing genius Warren Buffett has some key advice. He's long been a proponent of putting money into an S&P 500 (SNPINDEX: ^GSPC) index fund and holding it for many years.
It's great advice. But you may want to tweak it.
You may want to look beyond the S&P 500
The S&P 500 index consists of the 500 largest publicly traded companies by market capitalization. A big reason Buffett has long recommended S&P 500 index funds for everyday retirement investors is that it's an easy way to grow your savings without having to do a ton of research.
The S&P 500, by nature, gives you instant diversification in your portfolio. That's important, as it could help you not only grow your money, but protect it during periods of stock market volatility. But while Buffett's advice may work well for a lot of people, you may want to think beyond the S&P 500 and consider a total stock market index fund instead.
As the name implies, a total stock market fund gives you access to a broader range of investments. The S&P 500, by nature, consists of large-cap stocks. That's a good thing, since those tend to be established companies.
Midcap and small-cap stocks can be riskier than large-cap stocks, but they can also offer a lot of upsides in terms of growth. So excluding them from your portfolio could limit your returns.
Remember, too, that companies that start out small can eventually grow into larger ones. By investing in a total stock market fund, you can capture some of that growth without having to research those smaller companies individually.
Of course, the flip side to all of this is that you might see more volatility with a total stock market fund than an S&P 500 index fund. You'll need to assess your appetite for risk and weigh it against your goal of growing your money.
Consider your investing strategy carefully
You may decide to follow Warren Buffett's advice and go all-in on an S&P 500 index fund. Or, you may decide to stray from his advice a bit and invest in a total stock market fund. Either way, it's important to recognize that both approaches won't allow you to beat the broad market.
If your goal is to do that, you'll need to be prepared to hand-pick a portfolio of stocks. That means doing a lot of research and tracking each company's performance. It also means looking at your portfolio frequently and rebalancing as needed.
If you're going to choose stocks individually, make sure you're branching out across a range of industries. The beauty of an S&P 500 or total stock market fund is getting built-in diversification without having to do that work.
You should also know that if your retirement account of choice is a 401(k) plan, you typically won't be able to put your money into individual stocks. To do that, you may need to open an IRA separately, or invest in a taxable brokerage account.
If you're not sure what to do, remember that it never hurts to take a hybrid approach. You could put some of your money into a broad market index fund, and also hold some stocks individually. That may give you the best of both worlds -- guaranteed diversification, with the chance to do better than the broad market if you choose the right companies to invest in.
