How to Invest in an S&P 500 Index Fund and Retire 10 Years Earlier
Today, I’m going to show you exactly how to invest in an S&P 500 Index Fund. Even better, I’ll show you how you can use it to shave years off your working career.
In fact, I used this strategy to build a $92,000 net worth by the age of 24.
If you’re brand new to investing, don’t worry. I’ll explain all the fancy terminology and answer any questions you might have along the way.
And at the end of this post, I’ll walk you through the process step-by-step, so you can get the ball rolling within the hour. Let’s get started.
First things first, let’s break down what an S&P 500 Index Fund is. After all, the key to every investing strategy is to understand what you’re investing in.
We’ll start with the concept of an index.
Indexes are a way to track the performance of a group of assets. Some are designed to track a specific industry like the Technology sector, while others may follow an asset class like government bonds.
The S&P 500 is an example of the broadest type of index. It’s a weighted list of companies that a committee of experts put together to represent the American economy. To get selected, companies have to meet strict criteria in areas like:
- Market cap (company size)
- Liquidity (how easily company shares are bought and sold)
- Sector classification (the company’s industry – like Finance, Health, or Energy)
The committee only picks from corporations that are publicly listed on stock exchanges, like the New York Stock Exchange (NYSE). These are the ones that investors like you and I can buy and sell pieces of, called shares.
Funds are also listed on these stock exchanges and can be traded in the same way. By the way, a fund is any pool of money invested to provide a return.
Hedge funds, money-market funds, and index funds are all very similar. Don’t get intimidated if someone name-drops a fund type that you’ve never heard of.
They take different strategies or invest in different assets, but their goal is always the same. Turn money into more money.
Index funds come in two forms, Exchange Traded Funds (ETFs) and Mutual Funds.
Here’s a quick summary of the relevant differences between the two:
- Minimum Investments
- ETFs are lower
- Mutual Funds are higher
- ETFs are real-time (like a stock)
- Mutual funds are calculated ONLY at the end of the day
- ETFs need to be purchased manually
- Mutual funds can be set to automatically buy at regular intervals
- Ongoing Fees
- ETFs tend to be cheaper
- Mutual funds tend to be slightly more expensive
If you’re just getting started with investing, I recommend going with an ETF. You don’t need as much cash to get started and they tend to cost slightly less in fees and taxes. Plus, you’ll get more comfortable with investing when you’re forced to control it manually.
When you put all of these concepts together, you have an S&P 500 Index Fund: a lot of cash invested by millions of people into an asset that automatically tracks the returns of the biggest company stocks in the United States.
Now that we’ve established exactly what you’re investing in, let’s dive into how you’ll do it.
To get started with any investment, you’ll need at least enough cash to cover the initial purchase.
A quick Google of any fund will tell you the current price. And some of them can get pretty expensive. Take a look at Berkshire Hathaway, Warren Buffet’s company.
Yikes. So how much do you need to invest in an S&P 500 Index Fund? Lucky for you, a lot less than $272,000.
Here’s Vanguard’s ETF option, VOO.
A little more attainable, right?
Just because you have that $300, doesn’t mean it’s a good idea for you to buy right now. Before you put your money into an index fund, you need to make sure that cash isn’t needed more somewhere else.
Investing is risky, even in a relatively conservative fund like an S&P 500 Index Fund.
Remember, it’s composed of stocks. And stocks are volatile. Their prices bounce up and down constantly, and you need a long time horizon (think 10+ years) to be reasonably sure that you’ll balance out that volatility.
It’s best to avoid putting money that you’ll need anytime soon into the stock market. Put that cash in a savings account instead and keep it safe.
Make sure you ask yourself these questions before you buy. Do you have:
- Consistent monthly earnings?
- An emergency fund?
- Outstanding debt?
I encourage you to start only when you feel comfortable allocating a percentage of your stable income towards long-term investing. In other words, if you’re down to your last $300, don’t spend it on an index fund.
If you’ve done some thinking and you feel ready to start investing, you’ll need to choose a brokerage. Brokerages are the companies that let you buy and sell investments. These days, you’ll probably do it all on their websites.
They’re the middle man, and like every middle man, they take their cut of the profits for their services. You need to figure out which one is going to mooch off you the least.
This may vary a bit depending on your investment strategy. But you want to know how to invest in an S&P 500 Index Fund, so you’re probably smart enough to know not to day trade.
In which case, your priorities should be:
- Minimizing trade commissions
- Avoiding annual account fees
- Having a good selection of low-cost funds
You can deep dive into some of your different options here.
Or you can just go with my personal choice. I’m Team Vanguard for life.
They offer free trading commissions for ETFs, waive your annual fee if you sign up for electronic statements, and offer the best low-cost funds around.
To top it off, their values consistently line up with those of the individual, buy-and-hold investor. In fact, their founder, Jack Bogle, was the first to offer an index fund to the public back in 1975.
That fund eventually became the S&P 500 Index Fund you see still offered by Vanguard today. And that’s the fund that everybody else eventually copied.
When you go to sign up with a brokerage, they’ll ask you which type of account you want to open.
Unless you’re building a college fund for your child or working as an entrepreneur, you’ll want to start with an IRA or a general investing account.
Retirement funds (IRAs) come with special tax advantages, but you can only contribute $6,000 or so to them each year. If you save any more than that, (and I recommend you try) the rest will have to go to a general investing account.
General accounts don’t have any special attributes or tax incentives. Your contributions are made after tax, and any capital gains or dividends are taxed too.
Capital gains occur when you sell an asset for a profit, but dividends are paid out regularly while you still own it. They’re an incentive for investors to hold onto their shares. Fortunately, S&P 500 Index Funds are pretty tax efficient.
So don’t worry too much about which one you start with today. You can always open up a second or third account later, and you probably should.
In the meantime, here’s a quick rundown of the differences between the two IRA types:
- Get a deduction on your taxes this year
- Contributions and earnings grow tax-free
- Distributions are taxable when taken
- Can’t access any funds until 59 ½ years old
- Limited deduction if you’re also using a 401-K
- No deduction on your taxes this year
- Contributions and earnings grow tax-free
- Distributions are tax-free when taken
- Can take distributions only up to your contribution amount before 59 ½
- Limited contribution if your earnings are too high
Now let’s dive into why this approach to investing is so powerful.
There are three basic questions you can use to judge the viability of a long-term investment strategy:
- Return: How much money will it make you?
- Expenses: How much money will it cost you?
- Passivity: How much work will it take you?
For example, real estate is expensive and requires a lot of effort, but the returns can be huge when leveraged with debt. Bonds can be reasonably affordable and are mostly passive, but the long term returns will never match what you can get in the stock market.
But the S&P 500 Index Fund is a slam dunk across the board. You maximize your return and minimize your expenses while barely having to think about it.
Let’s use Vanguard’s S&P 500 ETF (VOO) again as an example.
- 11.69% price growth + dividend yield of 1.92% = 13.59% average over 10 years
- A measly .03%. On a $10,000 investment, that’s just $3 a year
- Just log onto Vanguard once a month and buy your funds in 5 minutes. Easy peasy.
More and more people are realizing this and shifting their investment strategies. In fact, index fund assets surpassed actively traded funds for the first time in 2019.
So how can you use this to your advantage? What does this mean for your working career and long-term retirement plans?
Now more than ever, dreams of financial independence are achievable for the median income earner.
Let’s examine some rough numbers on today’s average American retiree.
- They started saving in their 20s
- They retired around 60 years old.
- Their total savings is about $182,100
- They saved about $6,000 per year
These numbers aren’t a very high benchmark to beat, but that’s not the point we’re making today.
The point is, even if you save exactly like the average retiree during your career, you can still surpass their total savings at retirement long before your 60th birthday. Just by investing in an S&P 500 Index Fund. And it’s not even close.
Let’s do a quick case study to see how those numbers look.
Here are my assumptions:
- You invest $6,000 per year
- Your earnings grow untaxed in an IRA
- You invest only in Vanguard’s S&P 500 ETF (VOO)
- VOO continues to average the same returns it’s provided in the past (not guaranteed)
- Inflation continues to average 3.22% (Inflation is the rate at which prices rise over time)
When I put all that information into this calculator, you can see that it would only take you 15 years to build savings equivalent to those of our average American 60-year-old retiree.
Even if you waited until age 25 to invest, you’d break even by age 40. That’s 20 years ahead of schedule.
Of course, retiring at 40 on such a small portfolio probably isn’t in your best interest. Especially since you wouldn’t get the benefit of Social Security.
So let’s imagine you keep working and saving until age 50. When I increase the investing horizon on this calculator to 25, the results are much more comfortable.
Look at that. Ten years early and a few hundred thousand dollars richer.
You might think $600K is still too little to retire on. But keep in mind, these are the results when you save just $6,000 a year. Think of the possibilities for a more aggressive saver.
Feel free to play around with investment calculators like the one above to see just how much your investments can grow over time.
As promised, now I’ll show you step-by-step how to invest in an S&P 500 Index Fund.
In case you haven’t noticed yet, I’m a fan of Vanguard. So we’ll use the Vanguard website for our example and click on the Personal Investors link highlighted below.
This should take you to the following page, where you can find a button up top that says “Open an Account.”
Click that link and then choose the option on the left to get the process going.
You’ll need a couple of things to get started. Basically, a bank account and a steady income, like I said before. The process is pretty straightforward, and they outline it for you below.
Then it’s just a matter of filling out their application. Tell them you’ll fund the account via electronic bank transfer, and then pick your account type.
Remember, you can open up another type of account at any time. This choice only affects where your initial contributions go.
When that’s done, you’ll need to wait a bit to confirm your bank account. They’ll send you a couple of test deposits somewhere in the amount of 10-20 cents a piece (score!) in a day or so, and then you can confirm the amounts with Vanguard.
At some point, they’ll ask you to choose a settlement fund. This is where your contributions go before being withdrawn to make purchases.
The default one is fine. It’s basically a checking account with a very tiny return. Just keep as little cash in here as possible, since it does come with an expense ratio of .11%, for some reason.
Now, at long last, you can go in and buy your shares of an S&P 500 Index Fund. Hit the “My Accounts” button in their top menu and then click “Buy and Sell” to get to this page.
Choose Trade ETFs or Stocks, and you’ll end up here. Your Final Destination. Choose your account, transaction type, and type VOO into the symbol box. You can buy as many shares as you have the cash to cover.
You’ll need to pick an order type. I recommend you choose Limit. That will ensure that your order only goes through if Vanguard can execute the purchase at the price you want.
By the way, make sure you set the limit number to what you see on the right and just hit continue. It’s very tempting to sit there and refresh over and over again hoping the price will go down (yes, I’ve done it), but it’s really not worth the 40 cents. Or your time.
All right, we’ve covered all you need to know about how to invest in an S&P 500 Index Fund today. You know where, when, why, and how to go about it.
Now I’d like to hear from you.
Is today the day you bought your first investment? Or did you read this post and decide to wait?
Either way, I’d love to get your story. Let me know in the comments below!