How Should a Beginner Invest in Stocks? Try This Index Fund.

Let’s start at the very beginning
A very good place to start
When you read, you begin with A-B-C
When you sing, you begin with do-re-mi
— lyrics to Do Re Mi

If you’re a beginning investor, you should also start at the beginning — perhaps with this A-B-C: Apple, Bank of America, and Costco. For new investors, there are few better initial investments to make than a simple, low-fee index fund such as the Vanguard S&P 500 ETF (VOO 0.30%), which tracks the S&P 500.

What’s the S&P 500?

The S&P 500 is an index (a grouping) of 500 of the biggest companies in the U.S. Here are its recent top 10 components, by weight:

Data source: Slickcharts.com.

The index is a market-capitalization-weighted one, meaning that the biggest companies in it will move its needle the most. That’s evident just from the table above. It shows how much more influence Microsoft has than Berkshire Hathaway, and Berkshire Hathaway is the 10th most influential component!

Altogether, these 500 companies make up about 80% of the total value of the U.S. stock market. So the S&P 500 is often used as a proxy for the market — though it does omit lots of smaller companies.

Why invest in an S&P 500 index fund?

There are many reasons why you might start your investing life by plunking your long-term dollars (ones you won’t need for at least five, if not 10, years) into an S&P 500 index fund. For starters, it can be all you need to amass a fat nest egg. The S&P 500 has averaged annual gains of close to 10% over long periods — which is a rather powerful growth rate.

The table below shows how much you might amass if you invest $7,000 annually (that’s the current maximum contribution allowed for IRAs for most people) annually and earn 8% or 10%. Note that you can always invest much more than $7,000 annually via a 401(k) account or just a regular brokerage account at a good brokerage. And the more you can invest, the more you can amass. If you can swing $14,000 per year — perhaps due to being a two-income household — you can double the numbers below.

Source: Calculations by author.

Here’s another good reason to favor the S&P 500: According to the folks at S&P Dow Jones Indices, 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. So an S&P 500 index fund is not a compromise dooming you to sub-par returns. It will deliver roughly par returns — which will outperform many professional money managers.

Why does the S&P 500 index perform so well? One reason is that it’s adjusted over time. Every now and then, some stocks get the boot, while others are added to the index. The ones that depart have likely been struggling or at least haven’t been growing briskly, while the new ones have grown enough to merit consideration for the index.

Need more reasons? Well, an S&P 500 index fund gives you instant diversification. You’ll immediately be invested in technology companies (specializing in cloud computing, semiconductors, cybersecurity, and more), financial services companies, healthcare companies, consumer products companies, energy companies, retailers, and much more. You’ll essentially be betting that the American economy will do well.

There’s a good chance that your 401(k) account offers an S&P 500 index fund for your contributions. And you can always invest in one on your own — in your IRA or a regular brokerage account.

Beyond the basics

You can stop there and just put all your long-term money in one or more good index funds (there are many others that track indexes other than the S&P 500). You needn’t learn much more.

But if you’d like to aim for higher returns, you can take time to learn a lot more about investing, industries of interest, and great companies. But amassing a hefty nest egg for your retirement doesn’t have to involve more than a solid, low-fee S&P 500 index fund.