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.
Alert: our top-rated cash back card now has 0% intro APR until 2025
This credit card is not just good – it’s so exceptional that our experts use it personally. It features a lengthy 0% intro APR period, a cash back rate of up to 5%, and all somehow for no annual fee! Click here to read our full review for free and apply in just 2 minutes.
FAQs
Index fund investing might not seem as exciting as buying individual stocks, but that doesn't mean they can't build wealth effectively. It is possible (even likely) to build a million-dollar retirement nest egg using nothing but index funds.
Is it good to invest in index funds for retirement? ›
Yes. Index funds are a great choice for retirement due to their long-term growth potential, low fees, and diversification. Start early and let time work for you!
Can I live off of index funds? ›
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.
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.
What are 2 cons to investing in index funds? ›
Disadvantages of Index Investing
- Lack of downside protection: There is no floor to losses.
- No choice in the index fund's composition: Cannot add or remove any holdings.
- Can't beat the market: Can only achieve market returns (generally)
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 is the $1000 a month rule for retirement? ›
The $1,000-a-month retirement rule says that you should save $240,000 for every $1,000 of monthly income you'll need in retirement. So, if you anticipate a $4,000 monthly budget when you retire, you should save $960,000 ($240,000 * 4).
How long will $400,000 last in retirement? ›
Using our portfolio of $400,000 and the 4% withdrawal rate, you could withdraw $16,000 annually from your retirement accounts and expect your money to last for at least 30 years. If, say, your Social Security checks are $2,000 monthly, you'd have a combined annual income in retirement of $40,000.
How long will $500,000 last in retirement? ›
According to the 4% rule, if you retire with $500,000 in assets, you should be able to withdraw $20,000 per year for 30 years or more. Moreover, investing this money in an annuity could provide a guaranteed annual income of $24,688 for those retiring at 55.
Can you retire a millionaire with index funds? ›
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.
Retiring at 65 with $1 million is entirely possible. Suppose you need your retirement savings to last for 15 years. Using this figure, your $1 million would provide you with just over $66,000 annually. Should you need it to last a bit longer, say 25 years, you will have $40,000 a year to play with.
Why don t the rich invest in index funds? ›
Wealthy investors can afford investments that average investors can't. These investments offer higher returns than indexes do because there is more risk involved. Wealthy investors can absorb the high risk that comes with high returns.
Are index funds good for retirement? ›
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).
How much would $10,000 invest in the 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.
What happens to index funds when the market crashes? ›
For instance, in a major sell-off, when an index itself loses value, an index fund holding the underlying securities of the index will also lose value. However, investors who hold on to their fund investments should see the fund value increase as the value of the index itself reverses course and increases.
Is it better to invest in 401k or index funds? ›
A 401(k) account's major edge over an index fund is the tax advantage. Contributions to 401(k) accounts are pre-tax. Owners don't pay taxes on dollars they put in or the earnings from their investment portfolio until they start withdrawing funds.
Is an S&P 500 index fund good for retirement? ›
Investing in a broad market index fund can take a lot of the guesswork away. If you're not a confident investor, an S&P 500 index fund could be your best choice. If you're willing to do the work and research stocks individually, you might enjoy stronger gains in your retirement account.
Should I put my pension in an index fund? ›
Retirement funds and index funds are for people with different needs. If you want to have exposure in equity index then an index fund will be the right option. But, if you are aiming for a stress-free retirement then you must invest in a retirement fund.
Are index funds better than IRA? ›
Both Roth IRAs and index funds are solid options for retirement savings. Investing in an index fund allows you to invest without putting too much of your money in any single investment. By investing in index funds within a Roth IRA, you allow your money to grow tax-free.
