When it comes to equity investing, you can be an active investor and buy individual stocks or you can look to hold ETFs or indexes in your portfolio. If you have don’t have the time and expertise to identify good quality stocks, it makes sense to look at passive investment options such as index investing.
ETF or index investing remains the safest best for equity investors as these instruments provide you with diversified exposure to a basket of stocks across sectors. One of the most popular index funds in the world is the S&P 500.
Here’s why this index fund should be a core part of your portfolio.
Steady returns
In the last five and a half decades, the S&P 500 has repeatedly proven its ability to grow your capital at a steady pace. This makes the index fund that tracks the market a sensible way to save for retirement.
A long-term investor would have derived solid gains over a period of time especially if they reinvested dividends to benefit from compounded gains. Since 1965, the S&P 500 has generated an annual return of 10%, easily outpacing inflation and creating massive wealth for investors.
In case you expect the S&P 500 to generate annual returns of 10% in the next three decades and if you invest $446 each month, your portfolio will be worth $1 million by the end of the forecast period.
The S&P 500 is well-diversified
The S&P 500 index fund provides investors with exposure to the largest companies in the U.S. including tech giants such as Apple (NASDAQ: AAPL), Amazon (NASDAQ: AMZN), Alphabet (NASDAQ: GOOG)(NASDAQ: GOOGL), and Facebook (NASDAQ: FB). For most retirees, these returns would be ideal, especially if you combine these gains with social security payouts.
We can see how with the right retirement timeline and the correct amount invested, you can retire a millionaire with the S&P 500 index fund. However, as with most investments, even index funds carry certain risks.
While noted investor Warren Buffett has warned betting against the U.S. economy, investors should realize that the latter may not be able to grow at the same rates that prevailed in the 20th century and the early part of the 21st century.
Investors should also be patient and invest in the S&P 500 irrespective of the state of the economy. You need to commit to a buy-and-hold strategy and have nerves of steel. If you watch your portfolio value drop by 30% (like it happened in March 2020) or even 50% (remember the financial crash of 2008-09?), you might want to sell your equity holdings and instead buy conservative instruments such as a low-yield bond, in order to smooth out the dips.
If you are a U.S. citizen, there is a good chance investing in the S&P 500 carries a home-market bias. Several investors might want to further diversify their portfolio by adding international funds in other emerging or developed markets.
The bottom line
Investors with a long-term horizon should allocate a major portion of their portfolio to well-diversified index funds like the S&P 500. In short, you need to be disciplined and invest every month in the index fund to benefit from dollar-cost averaging as well as the power of compounding.
Related: What Happens to Your Money When the Stock Market Crashes?
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