Warren Buffett still actively manages Berkshire Hathaway's massive portfolio, but he's given his wife surprisingly simple directions for managing her inheritance once he passes away: Invest 90% into a low-cost S&P 500 index fund and the remaining 10% in short-term government bonds.
John Bogle, who popularized index funds through The Vanguard Group, shared a similar view. Bogle argued that since most fund managers couldn't consistently beat the S&P 500, it was smarter to simply invest in a fund that passively tracked the benchmark index. S&P 500 index funds also charge much lower fees than actively managed funds.
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Today, it's easy to invest in the S&P 500 through index funds, which are only traded once per day, or exchange-traded funds (ETFs), which are actively traded throughout the day. So today, I'll explain why one of the most popular ETFs -- the Vanguard S&P 500 ETF (VOO -0.39%) -- could easily turn modest $100 monthly investments into more than $40,000.
What is the Vanguard S&P 500 ETF?
Vanguard's S&P 500 ETF was launched in 2010. It passively invests in the S&P 500 index, charges a low expense ratio of 0.03%, and has a minimum investment of just $1.
If you had invested $100 each month into the ETF since its inception, you would have invested $16,500 over 165 months. After including reinvested dividends, the total value of those holdings would now be worth $45,943 -- representing a 178% gain -- and generating out about $600 in annual dividends.
The S&P 500 has delivered an average annual return of about 10% since 1957. Assuming it grows at a similar rate over the next few decades, the Vanguard S&P 500 ETF could generate comparable gains over the next two decades.
But is dollar-cost averaging actually the best idea?
By investing $100 into the S&P 500 every month, investors can use dollar-cost averaging to tune out the near-term noise. You would buy more shares of the ETF when the market's down, and buy fewer shares when it's rallying.
That's a safe approach for most investors who don't have time to follow the markets, but there are also some major drawbacks. The ETF has actually rallied 393% since its inception and generated a total return of 539% after including its reinvested dividends. If you had made a lump sum investment of $16,500 in Vanguard's ETF and simply left it alone, your investment would be worth about $105,500 today and paying $1,370 in annual dividends.
The lump sum investment generated bigger gains because you would have acquired all of your shares at a lower price instead of paying higher average prices over the subsequent years. So even if you can't make a big upfront investment, you should still try to increase your monthly investments whenever possible to boost your long-term returns.
But mind the near-term risks
Putting $100 into this ETF each month is a simple way to stay invested with minimal risk, but investors shouldn't put any cash they'll need within the next few years into this fund -- since the S&P 500 can still experience prolonged drawdowns.
The S&P 500 is historically expensive right now at 25 times forward earnings, and information technology stocks -- including Microsoft, Apple, and Nvidia -- account for more than 30% of the entire index. Many of those stocks are being lifted higher by the buying frenzy in AI stocks. If those market leaders stumble over the next few quarters, the S&P 500 could experience a sharp pullback.
That said, Vanguard's S&P 500 ETF is still a great long-term play for investors who don't plan to cash out for another few decades. Lump sum investments might fare better, but dollar-cost averaging is still a safe way to ride the markets higher.
