In this edition of Investing chronicles, Lockstep CEO Paul Farah explains why investing in the US stock market, especially through S&P 500 index funds, offers a proven strategy for significant returns.
Several close friends and community members have recently asked me how they should invest their money.
Given the frequency of this question and whether you have a lump sum or want to invest monthly, here’s a guide on how to grow your wealth over the long term.
Why invest in the stock market?
The stock market, particularly the US market, has consistently proven to be one of the best places to grow wealth.
Over the last 50 years, the S&P 500 Index, representing the 500 largest US-listed companies, has outperformed other popular asset classes such as real estate (US housing prices), corporate bonds, and gold.
This is what a $1 000 invested 50 years ago looks like today:
Summary of the graph above:
With an average annual return of around 11%, it’s easy to see why the US stock market is so attractive.
It didn’t involve any sorcery or a superior IQ. All you had to do was invest in the index and wait, regardless of the Fed’s next move, consumer sentiment, or the political landscape.
The importance of long-term investing
To receive the full benefit of the S&P 500’s returns, you must be invested long-term.
Compounding at 11% per year isn’t very useful over six months or even a year or two. $1 000 earns you $110 in your first year, but in your 30th year, you earn over $2 000 a year, more than double your original investment.
(Compounding is when your investment gains earn returns themselves, creating a snowball effect that grows your wealth exponentially over time.)
The key is to stay invested through market fluctuations and not try to time the market. Market crashes and corrections are natural, but history shows that the market recovers and grows over time. If the market crashes, do not panic and sell; if you can, try to invest more.
How to invest: index-tracking funds
So we have decided that investing in the market is the way to go; now we need to discuss how.
Research shows that only 12% of professional money managers have outperformed the stock market in the last 15 years. You will unlikely do much better, given this isn’t your day job.
Therefore, rather than trying to outperform the market, the aim is to match the market’s performance with index-tracking funds. These funds mimic the composition and performance of an index like the S&P 500, providing a simple and effective way to invest in the stock market.
For more details, read Where I would invest my money from March.
Which funds to choose
There are many index-tracking funds to choose from but here are three well-known S&P 500 index-tracking exchange-traded funds (ETF):
These ETFs are popular due to their low fees and reliable performance. Low fees are crucial because high fees can significantly erode your earnings over time.
How to buy an index-tracking fund
Buying the fund is straightforward:
Step 1: open a broker account
Opening a stock broker account is the same as opening any ordinary bank account.
Look for brokers that are, first and foremost, reputable and well-established. Next, make sure they offer low trading fees, a user-friendly platform, and good customer service.
I would consider using the following based on where I live:
Step 2: transfer money
Next, you have to fund your account, which is as simple as transferring money from one bank account to another.
Step 3: buy the index-tracking fund
Purchase your chosen index-tracking ETF just like you would a stock.
- Select the right ticker (as per the table above).
- Select how much money you want to invest.
- Buy at the current price.
Picking an investment strategy that works for you
For simplicity, there are two main strategies to consider when investing in an index-tracking fund.
1. Lump sum
Lump sum investing is exactly that – investing a lump sum in the market and leaving it there for as long as possible regardless of what the market does.
The advantage of a lump sum investment is that it will benefit from compounding more than monthly contributions, meaning it will grow more the longer you have it invested.
However, the risk is that you invest today, and the market crashes tomorrow. If history is any guide, it will recover and grow over time, so if the market does crash, DO NOT panic and sell; rather, if you can, try to invest more.
2. Monthly contributions
Investing a small amount regularly, known as dollar-cost averaging, reduces the impact of market volatility. By investing consistently, you buy more shares of the ETF when the price is low and fewer when the price is high, averaging out the cost of your investment over time. This strategy is less risky short term and helps build a disciplined investment habit.
Here are the returns of lump sum vs. monthly contributions over the last 20 years.
As you can see, $24 000 invested as one lump sum far outperforms the same amount invested in $100 increments every month – but only if invested for the long term.
Summary
Investing in the stock market, particularly through S&P 500 index-tracking funds, is a proven way to grow your wealth over the long term.
This approach is not sexy, and it’s not something your friends will be jealous of. But there is a high chance that in 10 years, your investments will outperform theirs, probably by a wide margin.
The key is to stay invested, allowing your money to benefit from compounding returns. Choose low-fee index funds, pick a reputable broker, and decide whether lump sum or monthly contributions suit your situation best.
If you have any questions or need further guidance, please reach out.
There’s plenty more to discover with Lockstep.
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DISCLAIMER
* Paul Farah has worked in financial markets since 2006, holding positions at prestigious firms from New York to South Africa. Now, he manages his own money and provides access to his entire portfolio through his company Lockstep Investing. The views and opinions shared are his own and are for informational purposes only, they are not intended to serve as investment advice and do not represent the views or opinions of Standard Bank. This information should be used as a starting point for generating investment ideas, and should not be relied upon as the sole basis for making investment decisions. Lockstep Investing (PTY) LTD and the Standard Bank of South Africa Limited will not be responsible for the results of any investment decisions made based on the views provided.
