This type of investment could help you build life-changing wealth, but it's not right for everyone.
Investing in the stock market can be daunting, but with the right investments, you can generate long-term wealth while limiting your risk.
S&P 500 index funds are a fantastic option for many people. Each fund tracks the itself, meaning it includes stocks from 500 of the largest and strongest companies in the U.S. By investing in just one index fund, you'll own a stake in hundreds of different stocks at once.
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An S&P 500 index fund is even highly recommended by legendary investor Warren Buffett, who owns this type of investment himself and often encourages other investors to own it as well.
That said, it won't be the right fit for every portfolio. Here are three reasons you may want to consider buying an S&P 500 index fund, and two reasons to avoid it entirely.
Why an S&P 500 index fund can be a great investment
1. It can limit your risk
Because each S&P 500 index fund contains hundreds of different stocks from a wide variety of industries, it offers fantastic diversification -- which is key to a healthy portfolio.
In general, the more variety you have within your portfolio, the safer your investments will be. If all your money is tied up in just a few stocks or many companies within the same industry, your portfolio could be hit hard if those stocks or industries don't perform well.
2. It's almost guaranteed to see positive long-term returns
There are never any guarantees when investing, but an S&P 500 index fund is about as close as you can get to guaranteed positive long-term returns.
In fact, analysts at Crestmont Research examined the S&P 500's rolling 20-year total returns to find out how many of those periods resulted in positive total gains. They found that in every single year examined, the S&P 500 saw positive total returns.
In other words, if you had invested in an S&P 500 index fund at any point in history and simply held it for 20 years, you'd have made money. While that doesn't guarantee future returns will also be positive, the odds are far and away in your favor.
3. It requires very little effort
One of the biggest advantages of investing in an index fund is that it requires next to no effort on your part. You don't need to choose individual stocks, and because it performs best over the long term, you also don't have to worry about when to buy or sell.
All you have to do is invest however much you can afford every month, then let the fund do all the heavy lifting. If you're looking for a low-maintenance, set-it-and-forget-it type of investment, an S&P 500 index fund may be a great fit.
Why to avoid an S&P 500 index fund
1. It doesn't allow for any customization
For those who prefer a more hands-on approach to investing, index funds may not be the best option. Because all of the stocks are automatically chosen for you, you can't customize your portfolio to fit your individual needs.
Also, if there are certain companies you'd rather not own, there's no way to opt out of investing in them when you buy an index fund. If that's a deal-breaker for you, this investment might not be the best choice.
2. It can't beat the market
Perhaps the biggest downside of an S&P 500 index fund is that it can only earn average returns. This type of investment is designed to follow the market, so it's simply not possible for it to beat the market.
For many people, lower returns are a worthwhile trade-off for the ease and simplicity of an S&P 500 index fund. But if you're willing to put in a bit more time, effort, and research, investing in individual stocks could help you earn far more over time.
An S&P 500 index fund can be a fantastic choice for many investors, but it won't be the right fit for every portfolio. By understanding the pros and cons and considering what you want out of an investment, you can decide whether it's the right option for you.
FAQs
Investing in an S&P 500 fund can instantly diversify your portfolio and is generally considered less risky. S&P 500 index funds or ETFs will track the performance of the S&P 500, which means when the S&P 500 does well, your investment will, too. (The opposite is also true, of course.)
What are 3 advantages to index fund investing? ›
Over the long term, index funds have generally outperformed other types of mutual funds. Other benefits of index funds include low fees, tax advantages (they generate less taxable income), and low risk (since they're highly diversified).
What are 3 advantages and 3 disadvantages of investing in mutual funds rather than stocks or bonds directly? ›
Mutual funds come with many advantages, such as advanced portfolio management, dividend reinvestment, risk reduction, convenience, and fair pricing. Disadvantages include high fees, tax inefficiency, poor trade execution, and the potential for management abuses.
What are the cons of investing in the S&P 500? ›
Disadvantages of Investing in the S&P 500
The index has risks inherent in equity investing: The S&P 500 has risks inherent in equity investing, such as volatility and downside risk. Newer investors may find it difficult to tolerate such volatility.
Why do we need S&P 500 index? ›
The S&P 500 is a stock market index that measures the performance of about 500 companies in the U.S. It includes companies across 11 sectors to offer a picture of the health of the U.S. stock market and the broader economy.
What if I invested $1000 in S&P 500 10 years ago? ›
Over the past decade, you would have done even better, as the S&P 500 posted an average annual return of a whopping 12.68%. Here's how much your account balance would be now if you were invested over the past 10 years: $1,000 would grow to $3,300. $5,000 would grow to $16,498.
What are the pros and cons of using an index? ›
The advantages of indices are that they focus on key variables, while the disadvantages include their abstract nature, tendency to skip unmeasurable determinants, and their application of a single yardstick to diverse countries and regions.
What are index funds pros and cons? ›
The benefits of index investing include low cost, requires little financial knowledge, convenience, and provides diversification. Disadvantages include the lack of downside protection, no choice in index composition, and it cannot beat the market (by definition).
What are the advantages and disadvantages of stock market index? ›
While stock market indexes can provide a quick snapshot of how a particular market is performing, they also have some disadvantages. For example, because indexes are created using a weighted average of the stocks within the index, they may not accurately reflect the performance of any one particular stock.
What are two advantages and disadvantages of mutual funds? ›
Mutual funds have pros and cons like any other investment. One selling point is that they allow you to hold a variety of assets in a single fund. They also have the potential for higher-than-average returns. However, some mutual funds have steep fees and initial buy-ins.
However, an active investment strategy also has certain limitations like:
- More expensive: Actively buying and selling a stock or mutual fund asset adds transaction fees, making active investing costlier than passive investing.
- High tax bill: Active managers have to pay high taxes for their net gains yearly.
Mutual funds allow investors to dollar-cost average over time and reinvest dividends, enabling compound growth. However, taxes on capital gains distributions and dividends can make them less tax-efficient. While mutual funds provide diversification, they still carry market risk based on the underlying securities.
Why don t people invest in S&P 500? ›
The stock market has proved to be a great investment in the long run, but over the years it has had its fair share of bumps and bruises. Investing in an index fund, such as one that tracks the S&P 500, will give you the upside when the market is doing well, but also leaves you completely vulnerable to the downside.
What are the advantages of Investing in the S&P 500? ›
The key advantage of using the S&P 500 as a benchmark is the wide market breadth of the large-cap companies included in the index. The index can provide a broad view of the economic health of the U.S. because it covers so many companies in so many different sectors.
Is S&P 500 a good idea? ›
Ever since the S&P 500 index was devised, it has built an impeccable track record of earning positive returns over time. In fact, research shows it's actually harder to lose money with the S&P 500 than it is to make money if you keep a long-term outlook.
What is the 20 year return of the S&P 500? ›
The historical average yearly return of the S&P 500 is 9.88% over the last 20 years, as of the end of April 2024. This assumes dividends are reinvested. Adjusted for inflation, the 20-year average stock market return (including dividends) is 7.13%.
Should I invest $10,000 in S&P 500? ›
Assuming an average annual return rate of about 10% (a typical historical average), a $10,000 investment in the S&P 500 could potentially grow to approximately $25,937 over 10 years.
Why would someone rather invest in an index fund? ›
They offer a simple, no-fuss way to gain exposure to a broad, diversified portfolio at a low cost for the investor. They are passively managed investments, and for this reason, they often have low expense costs. In bull markets, these types of funds can provide attractive returns as the market rises, lifting all boats.
How much money was $1000 invested in the S&P 500 in 1980? ›
In 1980, had you invested a mere $1,000 in what went on to become the top-performing stock of S&P 500 (^GSPC 0.70%), then you would be sitting on a cool $1.2 million today. That equates to a total return of 120,936%. The stock? None other than Gap (GPS 0.57%).
