The S&P 500: A Simple Investing Strategy

This content is for educational purposes only. This blog discusses past returns of the S&P-500 and is not a recommendation to invest in the S&P-500.  

Many investors seek financial independence through simple, long-term strategies. Historically, the S&P 500 ETF (ticker: VOO) has outperformed most professional money managers over time. Let’s explore how this approach works and why it’s become a popular choice among long-term investors.

Introduction to the S&P 500 ETF

Before diving in, let's clarify what an S&P 500 ETF is. ETF stands for Exchange Traded Fund. Essentially, an ETF is a basket that holds various stocks and tracks a specific index. The S&P 500 ETF tracks the performance of the S&P 500 Index, which represents 500 of the largest companies in the United States.

Long-Term Returns of the S&P 500

Historically, the S&P 500 has delivered strong long-term performance. Over the past decade, the index returned about 12% annually on average, and roughly 10% over longer periods. While past performance doesn’t guarantee future results, it highlights the potential of consistent market exposure over time.

To illustrate the concept of compounding, imagine someone investing $8,000 in an S&P 500 ETF at age 18 and leaving it untouched until age 66. If the investment grew at an average of 10% per year, it could exceed $1 million by retirement.

The Power of Compounding

To illustrate further, consider another hypothetical example. If someone invested $20,000 at age 35 and achieved an average annual return of 10%, the investment could grow to just over $500,000 by retirement. The key idea is that compounding, earning returns on previous returns, plays a powerful role in long-term wealth building.

Understanding ETFs and the S&P 500 Index

An ETF, such as one tracking the S&P 500, trades on a stock exchange much like an individual stock. The S&P 500 Index includes companies across 11 sectors and 24 industry groups, offering broad market representation.

This structure provides diversification—meaning the overall performance reflects many companies rather than one. For example, if a single company in the index, such as Microsoft, drops 30% in value, that loss may be offset by gains elsewhere. Diversification can therefore help smooth volatility compared to holding a single stock.

The Advantages of Diversification

Diversification is one of the defining features of an S&P 500. The index covers many sectors, including technology, healthcare, financials, and consumer discretionary. Because these industries often perform differently, the index’s broad exposure can help reduce the impact of any single sector’s underperformance.

Comparing S&P 500 Performance with Actively Managed Funds

Interestingly, the S&P 500 has historically outperformed many mutual funds and hedge funds over the long term. According to various studies, only about 5% of actively managed funds outperform the S&P 500 over a 20-year period. A recent study highlighted that none of the mutual funds consistently outperformed the market over the past five years. Furthermore, Warren Buffett has long advocated for investing in index funds, arguing that most investment professionals cannot beat the market over extended periods.

In a notable bet made in 2007, Buffett wagered that the S&P 500 Index would outperform a portfolio of hedge funds over ten years. The S&P 500 did indeed outperform, highlighting the historical strength of passive market exposure. 

Risks and Mitigating Strategies

While an S&P 500 ETF offers broad market exposure, it also carries risks. Market conditions can cause the index to become overvalued or undervalued at different times. For example, entering the market right before a major peak or downturn can impact returns. One approach some investors use to manage timing risk is called Dollar Cost Averaging (DCA), where investments are made at regular intervals over time.

Dollar Cost Averaging Explained

Dollar Cost Averaging (DCA) is an investing approach where a fixed amount of money is allocated to an ETF or similar investment at regular intervals, regardless of market conditions. For instance, someone contributing $5,000 annually might spread it across monthly or quarterly purchases. This method illustrates how investing gradually can smooth the purchase price over time, rather than relying on a single market entry point.

How Investors Access an S&P 500 ETF

An S&P 500 ETF can be bought and sold through most online brokerage platforms, just like individual company shares. Each ETF has a unique ticker symbol—for example, “VOO” is one of several funds that track the S&P 500 Index. Investors generally make transactions through their chosen broker’s platform, following its standard trading process.

Conclusion

Investing in an S&P 500 ETF is often discussed as a simple, long-term approach to market participation. Historically, the index has performed well compared with many actively managed funds, though outcomes always vary.