During the Berkshire Hathaway annual meeting in 2020, billionaire and legendary investor Warren Buffett told the audience, “in my view, for most people, the best thing to do is own the S&P 500 index fund.”
It’s a sentiment Buffett has stood by and repeated because he believes it’s a way for investors to help mitigate the risks that come with choosing individual stocks.
“The trick is not to pick the right company. The trick is to essentially buy all the big companies through the S&P 500 and to do it consistently and to do it in a very, very low-cost way,” he told CNBC in 2017.
The S&P 500 is a market index that tracks the stock performance of around 500 large-company U.S. stocks, including Amazon, Google parent company Alphabet, Meta and Visa.
While the index is not immune to overall market downturns, long-term investors have historically earned a nearly 10% average annual return. However, as with all investments, it’s important to note that past performance can’t be used to predict future results.
Here’s how much you’d have now if you’d invested $1,000 in the S&P 500 about one, five and 10 years ago:
If you had invested $1,000 into the S&P 500 about a year ago, your investment would be worth about $942 as of April 20, according to CNBC’s calculations.
Had you invested $1,000 into the S&P 500 about five years ago, your investment would have grown to about $1,689 as of April 20, according to CNBC’s calculations.
And if you had put $1,000 into the S&P 500 about a decade ago, the amount would have more than tripled to $3,217 as of April 20, according to CNBC’s calculations.
Why index funds can be a smart investment
While you can’t directly invest in the index itself, choosing to buy an S&P 500 index mutual fund or exchange-traded fund (ETF) gives you exposure to the index’s underlying stocks.
Financial experts generally consider these types of funds less risky than owning individual shares. By spreading your bets across some 500 companies, you lower the chances that a drawdown in any one particular stock would hurt your portfolio’s performance.
Additionally, because index funds are considered passive strategies, they tend to be low-cost investments. Index funds merely track a benchmark’s performance and therefore don’t employ a manager to run the fund, as is the case with “active” strategies.
As a result, the average passive fund charges an annual fee of 0.12%, compared with a 0.60% average fee among active funds, according to the latest data from Morningstar.
How compounding can help you build wealth
When it comes to investing, the sooner you start, the better. That’s because of compound interest, which can help your money grow.
Here’s how it works: After you make an initial investment, you theoretically earn a return on that principal amount. As interest is added to your balance, you begin to earn interest on that amount as well.
Say you invest $1,000 and earn an annualized return of 4%. A year later, your investment would have grown to $1,040 which is your original $1,000 investment plus four percent.
In year two, you’d earn 4% on the entire total, not just the principal balance of $1,000. By the end of the year, you’d have $1,081.60. In year three, you’d then earn 4% on $1,081.60, and so on.
You can use CNBC Make It’s compound interest calculator to see how it can help your money grow based on your initial deposit, your monthly or annual contributions, interest rate and time horizon.
Source : CNBC