Yahoo Finance Warren Buffett Swears By Index Funds: What You’d Make If You Invested $100 a Week
Warren Buffett, the CEO of Berkshire Hathaway, is one of the most successful investors in history. His ability to pick the right stocks netted him an average annual return of almost 20% between 1965 and today — that’s double the 10% average annual return of the U.S. stock market in that same period.
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However, despite his success in picking individual stocks, Buffett often discourages others from doing the same. Instead, he recommends that the average investor should put their money in low-cost index funds, such as the S&P 500. So what are index funds, and how much can you make investing in them?
What Are Index Funds?
An index fund is a collection of stocks that are grouped based on common characteristics or qualifications. The values of these individual stocks are averaged together into one price, which is the quoted price of the index. An index fund is created by an investment management company, such as Vanguard or Fidelity, to follow the index so that people can invest in it.
As the price of the index goes up and down, the value of your index fund investment does so, as well.
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The S&P 500: Buffett’s Favorite
Although there are a variety of market indexes out there, the most notable one is the S&P 500, a collection of 500 of the top stocks in the U.S. The S&P 500 is usually considered to be a good representation of the entire U.S. market, because it includes most of the top companies from various industries. This means that it’s also often used by financial analysts and news publications as a way to measure the overall health of the U.S. economy.
Buffett has said that he believes the average U.S. investor should regularly put their money into an S&P 500 index fund, and he’s bet that the S&P 500 will outperform the average actively managed fund in the long run.
Why Does Buffett Like Index Funds?
There are a few reasons Warren Buffett recommends index funds over actively managed funds or picking stocks yourself.
The first is the lower risk — because an index fund features a wide collection of stocks, it’s naturally diversified. You aren’t putting all of your eggs in one basket, and you don’t have to worry about losing your entire investment if one company fails.
Index funds also usually have lower fees than actively managed funds, through which fund managers buy and sell stocks in an attempt to outperform the market. In an index fund, you don’t have to pay high commission fees or salaries to fund managers — such funds just track their target index. Index funds are also transparent — you always know exactly where your money is going just by looking at the contents of the index.
Most importantly, broad-market index funds have historically had consistently high returns. The S&P 500, for example, has had an average return of around 10% since 1965.
How Much Can You Make Investing $100 per Week in Index Funds?
Using the 10% average annual return of the S&P 500, you can calculate your return on investment over time.
Returns After 10 Years (520 Weeks)
Your total contributions: $52,000
Investment return: $35,032
Total money in account: $87,032
Returns After 20 Years (1,040 Weeks)
Your total contributions: $104,000
Investment return: $208,771
Total money in account: $312,771
Returns After 30 Years (1,560 Weeks)
Your total contributions: $156,000
Investment return: $742,281
Total money in account: $898,281
Returns After 40 Years (2,080 Weeks)
Your total contributions: $208,000
Investment return: $2,208,941
Total money in account: $2,416,941
As you can see, because of compound interest, your returns grow exponentially the longer you keep investing. This is why it’s especially important to start investing for the future as early as possible — 10 years can make a world of difference!
How Long Would It Take You To Make $1 Million With $100 a Week in Index Funds?
If you were to invest $100 a week into the S&P 500, with an average annual return of 10%, you would have over $1 million in 32 years. However, the total amount of money you will have invested would be only $166,400. If you start investing $100 every week for 45 years, starting at 20 years of age, you could retire at 65 with $3.9 million in the bank.
Will S&P 500 Funds Always Be a Safe Investment?
An index fund can be considered to be a safer investment than picking individual stocks, because you’re not relying on the performance of just one company. Even if some of the companies in the S&P 500 fail, as long as the others perform well, you won’t lose money.
However, one important thing to note is that not every stock in the S&P 500 influences the index equally. Bigger companies make up a larger part of the index’s value, so changes in their stock prices can have a more significant impact on the overall index. This method of calculation is known as float-adjusted market capitalization weighting.
In recent years, more and more of the value of the S&P 500 and the overall U.S. stock market has become concentrated in the few companies at the top, such as Apple, Microsoft and Nvidia. The top 10 stocks in the S&P 500 now account for almost 30% of the value of the index. This means that the performance of your investment in the S&P 500 is more and more reliant on the performance of the top 10 companies.
Most of these 10 companies are in the technology sector — and some analysts worry that this concentration means that trouble in the tech sector may have a cascading effect that leads to an overall market crash, Barron’s reported.
To avoid index concentration, it may be a good idea to put some of your money into an equal-weight S&P 500 index instead. In an equal-weight index, your money is invested equally into each of the 500 companies that make up the index. This means that a larger company can’t have a disproportionate effect on the value of your investment.
However, everyone’s financial situation is different. If you’re not sure what the best investing strategy is for you, it’s a good idea to consult a financial advisor before making any significant financial decisions.
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This article originally appeared on GOBankingRates.com: Warren Buffett Swears By Index Funds: What You’d Make If You Invested $100 a Week
