Cheap passive investing trumps every other investment vehicle
For most of us, investing in broad-market index funds is the fastest and safest hands-off way to grow money over the long run, especially if we do not have the temperament, time, energy, or interest to invest.
Amongst all the noise on CNBC and agents trying to sell you annuities and unnecessary life insurance plans to earn juicy commissions, the above time-tested fact is drowned.
"In my view, for most people, the best thing to do is own the S&P 500 index fund," Buffett had once said. "The trick is not to pick the right company. The trick is to essentially buy all the big companies through the S&P 500 and to do it consistently and to do it in a very, very low-cost way," he further added.
There are a lot of different numbers cited for the average annual return of the index. And while the average return is easy to compute, it’s important to define what you’re computing.
The average annual return from 1928 through mid-2024 has been 7.9%.
But that overstates the compound annual growth rate of the index, which has been just 6.2%. Compound annual growth is a more accurate indication of how much an investment will grow over time.
Furthermore, those numbers ignore the impact of dividends and the potential to reinvest dividends, otherwise known as total return. The total return of the S&P 500 produced a compound annual growth rate of 10.1% over the past 96.5 years.
Unfortunately, inflation eats into those returns, which means the real compound annual growth rate of the index with dividends reinvested is 6.8%.
That last number is the most valuable for financial planning and determining how much spending power an investment today might produce well into the future. It also happens to be lower than the commonly used 7% or 8% expected returns from the market that most experts use in their planning assumptions.
Disclaimer—This is not to be construed as financial advice. I assume no liability for losses incurred as part of your investing process. I recommend that you seek advice from an actual professional advisor before investing. I do not work in finance. I am just an enthusiast with an interest in money management, and all my opinions are for informational purposes only.