Key Points
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If you’re committed to owning stocks for the long haul, simpler is usually better.
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Index funds also don’t create the temptation to buy low and sell high — a strategy that often does more harm than good.
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Even if you can’t save $500 per month, saving something sooner is better than tucking away bigger amounts of money later.
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Warren Buffett was right when he said, “There seems to be some perverse human characteristic that likes to make easy things difficult.” Too many investors are constantly hunting for the next great growth stock, only to suffer avoidable setbacks by owning the wrong risky stocks. These people could do at least as well — if not better — with a simpler approach. That’s investing a modest amount of money in the same boring exchange-traded fund (or ETF) the whole time you’re growing your nest egg.
Here’s the math, and a visualization of it.
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Image source: Getty Images.
Slow and steady wins the race
The ETF in question is the SPDR S&P 500 ETF Trust (NYSEMKT: SPY), although the Vanguard S&P 500 ETF (NYSEMKT: VOO) would do just as well. Both are built to mirror the performance of the S&P 500 (SNPINDEX: ^GSPC), which has logged an average annual gain of just over 10% since 1957. Some years were better. Other years were (much) worse. But the historical average is reliable enough to use as a projection of the index’s future performance.
So how much would you need to invest in one of these simple index funds to amass, say, $1 million — or more — over the course of 30 years? As the graphic below illustrates, tucking away just $500 per month in an investment that gains an average of 10% per year would leave you with just over $1.1 million in 30 years.
Data source: Calculator.net. Chart by author.
Notice that most of the net gain materialized in just the last third of the 30-year stretch. That’s when the power of compound interest really kicks in, driving exponential growth on all the gains made up until that point.
Something is better than nothing, and sooner is better than later
Granted, $1.1 million won’t be worth as much 30 years from now as it is today. In today’s dollars, it would be worth only $548,000, or about half of that projected amount. That’s still not bad, but it’s a far cry from being “set up” for life. You’d still need to watch your spending very carefully with a nest egg of that size, leaving little to no room for monetary missteps.
Just don’t forget that your disposable/investable income will also grow in step with inflation over the next three decades. You’re also likely to receive pay raises stemming from experience-based career advancement. This, of course, means you’ll have a good chance of ending the 30-year time frame with measurably more than $1.1 million.
The bigger takeaway, however, is this: Start saving as soon as you possibly can. Even if you can’t invest $500 per month, even half that amount is enough to make a difference. Time does most of the heavy lifting here, so you want to give every dollar you can as much time as you can to do that work.
This might put things in perspective: Earning 10% annually on a $1.00 investment would equal $2.59 in 10 years, and $6.73 in 20 years. After 30 years, though, that $1.00 would be worth $17.45.
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James Brumley has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Vanguard S&P 500 ETF. The Motley Fool has a disclosure policy.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
