Fortunately, Buffett's investing wisdom when it comes to retirement is simple: buy consistently at a S&P 500 the fund's index over time. When asked for investment advice, it's his go-to recommendation, according to Buffett.
The one-stop shop
THE S&P 500 (^GSPC 1.46%) is the most followed stock market index, tracking the 500 largest companies by market capitalization. Because the index contains large companies and industry leaders from all major industries, its performance is often used interchangeably with the stock market and the performance of the economy as a whole.
An investment in the S&P 500, for all intents and purposes, is an investment in the broader American economy.
The reason an S&P 500 index fund can be your ticket to a comfortable retirement is that it accomplishes four things: diversification, blue-chip stocks, low costs, and proven long-term results. As of January 2023, here's how the S&P 500 breaks down by sector:
- Communication services (7.3%)
- Consumer Discretionary (9.8%)
- Basic needs (7.2%)
- Energy (5.2%)
- Financial (11.7%)
- Health (15.8%)
- Industrial (8.7%)
- Information Technology (25.7%)
- Materials (2.7%)
- Real Estate (2.7%)
- Utilities (3.2%)
Within these sectors are blue-chip companies, which are industry leaders with a proven track record of delivering strong shareholder value over the long term. You can rarely go wrong as a long-term investor by leaning toward blue-chip companies.
Taxes matter
Probably one of the main reasons Buffett is a fan of S&P 500 index funds is their low fees. When investing in an index fund or exchange-traded fund (ETF), you should always pay attention to the expense ratio. Your expense ratio is charged as a percentage of your total investment each year, and while the differences may seem small on paper, they can actually add up over time.
To put this into perspective, let's compare two funds: one with an expense ratio of 0.03% and the other with an expense ratio of 0.30%. If both individuals invested US$1,000 per month and received an average annual return of 8% over 25 years, here's how their values would roughly differ once fees were accounted for:
Expense ratio Total amount paid in fees 0.03% $ 873,436 $ 3,835 0.30% $ 839,751 $ 37,520 Data source: Author's calculations.
With just a small difference of 0.27%, someone could have saved (or paid) over US$$ 33,600 in taxes. These taxes matter a lot in the long run. This US$$ 33,600 difference in taxes could represent a year's worth of retirement income for many people.
it's about consistency
Historically, the S&P 500 has returned, on average, about 10% per year over the long term. Past performance doesn't guarantee future performance, but assuming the trend continues, here's approximately how much someone could have accumulated over 25 years with multiple monthly investments:
Monthly contributions Total amount personally invested $ 500 $ 150,000 $ 590,082 $ 750 $ 225,000 $ 885,123 $ 1,000 $ 300,000 $ 1.18 million $ 1,500 $ 450,000 $ 1.77 million $ 2,000 $ 600,000 2.3 $ 6 million Data source: author's calculations.
Thanks to compounding—which occurs when the money you earn from investments starts generating income for you—you can accumulate much more than you personally invested. But for compounding to truly work its magic, you need time and consistency. Timing is simple—the sooner you start investing, the better.
Consistency is where investors can struggle the most. It's easier to remain consistent when your investments are steadily increasing. It's much harder to maintain consistency during downturns, when stock prices are seemingly falling daily or weekly. However, it's usually in your best interest to do so.
One of the best ways to maintain consistency is to use dollar-cost averaging. With dollar-cost averaging, you make fixed investments at specific times, regardless of stock prices. For example, if you decide to invest $ 1,000 per month in an S&P 500 index fund, you could choose to make biweekly investments of $ 500 on Fridays. Then, when Friday rolls around, the focus is on investing, no matter what.
Sometimes you'll invest when prices are rising; sometimes you'll invest when prices are falling. The idea is to even out your performance over the course of your career and avoid the stress of trying to time the stock market along the way. Investing for retirement doesn't have to be (and shouldn't be) difficult. Many people are comfortable in retirement simply by consistently investing in an S&P 500 index fund.
Stefon Walters holds no positions in any of the stocks mentioned. The Motley Fool has locations and recommends Berkshire Hathaway. The Motley Fool recommends the following options: long January 2023 $ 200 calls on Berkshire Hathaway, short January 2023 $ 200 calls on Berkshire Hathaway, and short January 2023 $ 265 calls on Berkshire Hathaway. The Motley Fool has a disclosure policy.
