Not only can you retire with just index funds, but you might be surprised at how much wealth you can build.
In full disclosure, I'm a big fan of investing in individual stocks. I own 48 of them in my portfolio. But that doesn't mean that you have to invest in individual stocks to build wealth in your retirement accounts.
In fact, the exact opposite is true. It is entirely possible to build a retirement portfolio entirely out of index funds, and to build a large retirement nest egg. Legendary investor Warren Buffett has actually said that investing in low-cost index funds is the best move for the majority of people, and says that "it is not necessary to do extraordinary things to get extraordinary results."
Here's a rundown of how effective a portfolio of index funds can be over long periods of time, as well as some tips to set yourself up for success.
Can you build a retirement nest egg with just index funds?
The short answer is a resounding yes.
Let's take a look at why this is. While past investment performance doesn't guarantee future results, the return of S&P 500 index funds has been about 9% to 10% annualized per year over long periods, depending on the exact timeframe you're looking at. Bond index funds have historically averaged about 4% to 5%. So, we'll say that a reasonable long-term expectation is for a portfolio of index funds to grow at a rate of 7% per year over your investing career.
We'll say that you set aside $6,500 per year in retirement accounts, the 2023 maximum IRA contribution, starting at age 25.
Based on this contribution rate, you would have contributed a total of $260,000 by the time you turn 65. But with a 7% compound growth rate, your money could be reasonably expected to grow to about $1.4 million. That's why it's absolutely possible to retire using just index funds. Now imagine if you had a 401(k) or other retirement plan in addition to an IRA.
Tips for index fund success
Index funds can allow you to put your retirement savings on auto pilot, but there are some steps you can take to set yourself on the right path.
Keep fees low
Index funds have investment fees, known as the expense ratio. These can vary significantly, even among index funds that essentially do the same thing. Vanguard and Schwab are two examples of firms that offer extremely inexpensive index funds, just to get you started.
Set an appropriate asset allocation
One good rule of thumb is to subtract your age from 110 to determine your ideal stock allocation. In other words, a 30-year-old should have 80% of their assets in stocks (or stock-based index funds) with the rest in fixed income, or bonds.
Contribute automatically
Timing the stock market is a losing battle, so the best way to set yourself up for strong returns over time is to contribute consistently over time. One great way is to automate your contributions and investments, which most online brokerages allow you to do. Try setting an automatic transfer each month, or on every payday.
Should you use index funds or buy individual stocks?
Like most personal finance topics, there's no one-size-fits-all answer to this question. The key thing to keep in mind is that if you have the time, knowledge, and desire to research and evaluate stock investments and create a diverse portfolio from individual stocks, it can be a good idea. If you don't, index funds are a completely solid way to create a retirement portfolio and can build wealth over time without the stress of relying on the success of individual companies.
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FAQs
So, it is possible retire solely by investing in an S&P index fund. With the caveat, that past performance does not guarantee future performance. But, I would bet on it. I invest in VTSAX, VFIAX and the equivalent ETFs, VTI and VOO.
Can you retire with index funds? ›
The best index funds for retirement offer growth potential and solid risk management that aligns with your time to retirement and risk tolerance. For long-term growth, consider broad-market equity index funds like the Vanguard Total Stock Market Index Fund (VTSAX) or the Fidelity 500 Index Fund (FXAIX).
Is it OK to only invest in index funds? ›
Investing legend Warren Buffett has said that the average investor need only invest in a broad stock market index to be properly diversified. However, you can easily customize your fund mix if you want additional exposure to specific markets in your portfolio.
Can you live off of an index fund? ›
The thing is, index funds are arguably the average investor's best bet when it comes to building a retirement nest egg. And yes, you can absolutely become a self-made millionaire using these ho-hum holdings. Here's proof, and a clear reason you'd want to use them over individual stocks anyway.
Is an S&P 500 index fund good for retirement? ›
As long as your time horizon is three to five years or longer, an S&P 500 index fund could be a good addition to your portfolio. However, any investment can produce poor returns if it's purchased at overvalued prices.
What is the 4% rule for index funds? ›
The 4% rule is a popular retirement withdrawal strategy that suggests retirees can safely withdraw the amount equal to 4% of their savings during the year they retire and then adjust for inflation each subsequent year for 30 years.
What are 2 cons to investing in index funds? ›
Disadvantages include the lack of downside protection, no choice in index composition, and it cannot beat the market (by definition).
Do billionaires invest in index funds? ›
In fact, a number of billionaire investors count S&P 500 index funds among their top holdings. Among those are Buffett's Berkshire Hathaway, Dalio's Bridgewater, and Griffin's Citadel.
How much would $10,000 invested in S&P 500? ›
Assuming an average annual return rate of about 10% (a typical historical average), a $10,000 investment in the S&P 500 could potentially grow to approximately $25,937 over 10 years.
Is there a downside to index funds? ›
For investors that take the time to learn and understand how to select individual stocks for their needs and properly manage a portfolio of them, they can achieve a lot of the benefits of index funds (great long-term returns with low fees) without some of the downsides (potential overvaluation, liquidity mismatches, ...
Broadly diversified index funds can be your investment vehicle for a ride to becoming a millionaire retiree, if the stock market performs as it has in the past. If you know little about investing and have no desire to learn more, you still can be a successful investor. That's because you have the power of index funds.
Are index funds 100% safe? ›
Because the goal of index funds is to mirror the same holdings of whatever index they track, they are naturally diversified and thus hold a lower risk than individual stock holdings. Market indexes tend to have a good track record, too.
How long should you stay in an index fund? ›
Ideally, you should stay invested in equity index funds for the long run, i.e., at least 7 years. That is because investing in any equity instrument for the short-term is fraught with risks. And as we saw, the chances of getting positive returns improve when you give time to your investments.
What if I invested $1000 in S&P 500 10 years ago? ›
According to our calculations, a $1000 investment made in February 2014 would be worth $5,971.20, or a gain of 497.12%, as of February 5, 2024, and this return excludes dividends but includes price increases. Compare this to the S&P 500's rally of 178.17% and gold's return of 55.50% over the same time frame.
Can you live off the S&P 500? ›
Once you have $1 million in assets, you can look seriously at living entirely off the returns of a portfolio. After all, the S&P 500 alone averages 10% returns per year. Setting aside taxes and down-year investment portfolio management, a $1 million index fund could provide $100,000 annually.
How much money do I need to retire? ›
10x your annual salary by 67
To fund an “above average” retirement lifestyle—where you spend 55% of your preretirement income—Fidelity recommends having 12 times your income saved at age 67, which is the normal Social Security retirement age.
Are index funds better than 401k? ›
The primary con of index funds when in comparison to 401(k) plans is the lack of any tax advantage. Fund purchases are made with after-tax dollars and investors pay taxes on any gains in their holdings, just like normal stock investments. There is also a lack of flexibility in index funds.
What is the main disadvantage of index fund? ›
While index funds are free from the fund manager bias, they are still vulnerable to the risk of tracking error. It is the extent to which the index fund does not track the index. Tracking error may occur in an index fund due to liquidity provisions, index constituent changes, corporate actions etc.
