So you're ready to invest in stocks, but you're new to the stock market. You have very little experience with this and your confidence level is low. That's OK. There's an option that even the most novice of investors can do well buying. That option is an exchange-traded fund (ETF).
ETFs are similar to mutual funds but they are more accessible to the average investor and they trade more like stocks. There are plenty of options to choose from and many of them will serve you well. For novice investors, there is one ETF in particular worthy of exploration first. It's a great one for beginners but does well for more experienced investors, too. Even Warren Buffett loves it!
The one I have in mind is a simple index fund, tracking the S&P 500. It's called the Vanguard S&P 500 ETF (VOO 1.29%). Here's why this one works well for novice investors.
Image source: Getty Images.
Why an S&P 500 index fund?
To understand what makes this ETF great, it helps to first understand what an index is and why you might invest in a fund that tracks it. Indexes are lists of stocks and/or holdings grouped based on specific criteria. For instance, the S&P 500 requires a company to have a market capitalization of at least $15.8 billion, be based in the U.S., be structured as a corporation, and at least 50% of its outstanding shares must be available for public trading. It must also report positive earnings in the most recent quarter. That means that S&P 500 companies tend to be some of the biggest and strongest companies in the world.
Index funds are made up of holdings that (roughly) mirror the index it tracks. Indexes track all sorts of asset classes and some asset classes perform better than others over the long term. For instance, stocks as a group tend to outperform other groupings. When tracking the returns of various asset classes between 1802 and 2021, Wharton Business School professor Jeremy Siegel noted in his book Stocks for the Long Run that the annualized nominal return was:
- Stocks: 8.4%
- Bonds: 5%
- Treasury bills: 4%
- Gold: 2.1%
- U.S. Dollar: 1.4%
As already noted, the S&P 500 index tracks roughly 500 of America's biggest companies, holding stock in all of them. The S&P 500 has performed well over a long time, averaging total annual returns topping 10% for decades. The ETF's return closely follows the returns of the index (less the management fees the ETF changes). Better still, index funds tend to outperform actively managed mutual funds. Over the past 15 years, the S&P 500 index outperformed a whopping 88% of managed large-cap mutual funds, and it outperformed 87% over the past decade.
Since an S&P 500 index fund follows 500-plus companies, it also offers instant diversification. The S&P 500 includes stocks representing just about every sector of the economy and tracks growth stocks as well as dividend-paying stocks. The dividend yield of the S&P 500 index currently averages 1.3%.
Meet the Vanguard S&P 500 ETF
As already mentioned, ETF returns are affected by their management fees. The Vanguard S&P 500 ETF is exceptional in part because its minuscule expense ratio (annual fee) is just 0.03%. A $10,000 investment in the ETF would include a very affordable $3 per year fee.
That fee is generally extracted from the annual return of the ETF. And that return is where this fund really shines. Past performance doesn't guarantee future results, but the average annual gain (total return) over various timeframes for the Vanguard S&P 500 ETF shows that this fund has been a solid performer since its inception in September 2010:
- Past year:27.8%
- Past three years: 9.6%
- Past five years: 15.1%
- Past 10 years: 13%
Those are solid returns. Over longer periods, the S&P 500 has averaged annual returns close to 10% (when not factoring in inflation). So a new investor shouldn't expect to average 13%, though that could happen. Even at a conservative 8% annual return (compounded), the results are enviable:
|
Growing at 8% For: |
$7,500 Invested Annually |
$15,000 Invested Annually |
|---|---|---|
|
5 years |
$47,519 |
$95,039 |
|
10 years |
$117,341 |
$234,682 |
|
15 years |
$219,932 |
$439,864 |
|
20 years |
$370,672 |
$741,344 |
|
25 years |
$592,158 |
$1,184,316 |
|
30 years |
$917,594 |
$1,835,188 |
|
35 years |
$1,395,766 |
$2,791,532 |
|
40 years |
$2,098,358 |
$4,196,716 |
Data source: Calculations by author. Note that the figures represent a compounded return on investment.
Clearly, an index fund can be all you need to amass a fat nest egg for retirement.
Here are the Vanguard S&P 500 ETF's Top 10 holdings, as of mid-September:
| Rank/Stock | Percent of ETF | Rank/Stock | Percent of ETF |
|---|---|---|---|
| 1. Apple | 6.89% | 6. Alphabet (Class A) | 2.17% |
| 2. Microsoft | 6.7% | 7. Alphabet (Class C) | 1.82% |
| 3. Nvidia | 6.2% | 8. Berkshire Hathaway (Class B) | 1.71% |
| 4. Amazon | 3.69% | 9. Broadcom | 1.51% |
| 5. Meta Platforms | 2.24% | 10. Tesla | 1.39% |
Data source: Vanguard.com. As of July 31, 2024.
You might notice that the list above includes all of the Magnificent Seven: Apple, Microsoft, Google parent Alphabet, Amazon, Nvidia, Facebook parent Meta Platforms, and Tesla. Anyone wishing they owned all of those amazing performers can quickly own a piece of them via an ETF like Vanguard's.
Even if the Vanguard S&P 500 ETF isn't right for you, investing in something should be a priority
The Vanguard S&P 500 ETF is a solid contender, but it's not the only ETF. Several others also follow the S&P 500 index. We should all be planning for retirement and saving and investing for it, to create additional future income. Social Security won't be enough for most of us to live on in retirement (and it was never intended to be the only source of income).
Get started soon, too, because the price of procrastination is high.
