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How a Boring S&P 500 Index Fund Can Make Anyone a Millionaire
Do you ever hear news reports that the stock market rallied, or that it tanked due to a piece of worrisome news? Often in these reports, the stock market refers to the S&P 500 index, which represents about 80% of the U.S. stock market.
An S&P 500 index fund is a fund that tracks the performance of the S&P 500 index. These are among the most popular investments on the planet, and for good reason. An S&P 500 index fund can make practically anyone wealthy, given enough time and patience.
Here’s how S&P 500 index funds work and why they’re a safe and reliable choice for most investors.
The S&P 500 is a stock index that tracks the performance of stocks in the S&P 500 index. (There are actually 503 stocks in the S&P 500 because three of the companies issue two classes of shares.)
It’s the most widely tracked stock index in the U.S., followed by the Dow Jones Industrial Average and the Nasdaq. When you hear in the news that stocks rallied or stocks plunged, often that means that the overall prices of those 503 stocks in the S&P 500 trended upward or downward.
An S&P 500 index fund is a pool of stocks designed to track the S&P 500. With one single investment, you’re automatically invested across all 500 companies in the index.
If the S&P 500 index goes up by 20% in a year and you’ve invested in an S&P 500 index fund, you’d expect returns of about 20%, minus investment fees, which are usually minimal. If the index falls by 20%, you’d expect the value of your investment to drop by 20% as well.
The goal isn’t to beat the market. Instead, an S&P 500 index fund aims to replicate the performance of the S&P 500 index as closely as possible.
Though some years, like 2022, the S&P 500 index will drop, it has about a 75% chance of gaining value in any given year, with annual returns averaging about 10%. Maybe that doesn’t sound like a lot, particularly in comparison to the mind-boggling returns investors saw in 2020 and 2021. But over long periods of time, those returns can produce substantial returns.
If you invested $500 a month and earned 10% annual returns, you’d have nearly $1 million after about 30 years. Your total investment? Just $180,000.
S&P 500 index funds have a phenomenal track record of building wealth over time. In fact Warren Buffett, who’s arguably the most successful stock picker on the planet, believes most investors should stick with S&P 500 funds instead of choosing their own stocks. In 2008, the Oracle of Omaha famously waged a bet with investment managers that an S&P 500 index fund could beat a pool of hedge funds over 10 years — and won.
Buffett believes in S&P 500 funds so much so that he’s directed the trustee of his estate to invest 90% of his money in S&P 500 funds for his wife when he dies. The remaining 10% will go to short-term Treasury securities.
There’s no “best” S&P 500 index fund. They’re made up of the same investments, so they pretty much deliver the same returns. And you don’t need to own more than one S&P 500 index fund since they all track the same index.
You can find S&P 500 funds that are exchange-traded funds (ETFs), which are traded like individual stocks on stock exchanges, or mutual funds, which you can buy directly from an investment company or with a brokerage account.
The main thing you should focus on is low fees. Look for an expense ratio of 0.1% or less. Choosing a fund with a low minimum upfront investment is also a good bet. With ETFs, you can often invest as little as $1 thanks to fractional investing. Some mutual funds require an upfront investment of $1,000 to $2,000, but many have no minimum investment.
Some low-cost options include the SPDR S&P 500 ETF Trust (SPY), Vanguard S&P 500 ETF (VOO), iShares Core 500 ETF (IVV) and the Fidelity 500 Index Fund (FXAIX).
Here are the pros and cons of S&P 500 index funds. Spoiler alert: There are a lot more pros than cons, especially if you’re a beginning investor.
Robin Hartill is a certified financial planner and a senior writer at The Penny Hoarder. She writes the Dear Penny personal finance advice column. Send your tricky money questions to AskPenny@thepennyhoarder.com.
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