Putting money aside each month and investing it for your retirement can be overwhelming. I remember the first time I started investing in a retirement account and wondering if it was the right decision and if it would actually make me any money.Â
Thankfully, you don’t have to be an expert at picking stocks to successfully grow your retirement account. And, for most people, you’ll probably make more money over 20 years if you take a hands-off approach. Here’s why.Â
The best place to invest your moneyÂ
If you don’t regularly keep up with the investing world, you might not know one of the most important things about investing: Passively managed funds almost always deliver larger gains than actively managed funds over the long term.Â
Those terms are a little technical, so what do they mean, exactly? Here’s the difference between the two:Â
- Actively managed fund: A financial expert picks and chooses investments to try and beat the market’s returns.Â
- Passively managed fund: The fund follows a market index, like the S&P 500, without trying to outperform it.Â
This means investing in an inexpensive index fund over the next two decades will likely earn you more than choosing a fund where someone actively picks stocks.Â
Indeed, some of the latest Morningstar data shows that actively managed funds beat passively managed funds less than 15% of the time over 20 years. This means you have a far better chance of making more money over the next 20 years by investing in a passively managed index fund.Â
As the famous investor and billionaire Warren Buffett 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.”
How much you should invest
Everyone’s budget is different, so there’s no one-size-fits-all answer to this question. In my own personal finances, there have been times when I’ve saved far less than I’ve wanted.Â
In general, most experts recommend setting aside 15% of your income. But that doesn’t mean you have to jump to that percentage right away. The financial experts at T. Rowe Price recommend saving just 6% of your income around age 25 and then gradually increasing the amount by 1% each year until you reach 15%.Â
The good news is that if your employer offers a 401(k) matching program, reaching that percentage will be much easier. For example, many employers will match half of your contributions, up to a certain percentage of your salary. This means if you contribute $10,000 per year to your 401(k), your employer could throw in an additional $5,000 — giving you a total of $15,000 saved that year.Â
I participated in a 401(k) matching program years ago at my old job, and the contributions I received from my former employer — now in an individual retirement account — are still earning money.Â
There’s no guarantee, but there is a good track record
Are you guaranteed to make money from your investments, even in an index fund? Unfortunately, no. However, investing in the stock market has, historically, paid off. The annual historic rate of return of the S&P 500 is 10.2%. Of course, there will be fluctuations from year to year, and it’s entirely possible you could lose money as well.
But putting your money into a passively managed index fund is one of the best ways to let your money grow over time. Just remember to be consistent with your investing and patient enough to let your investments rebound when the market hits an inevitable rough patch.Â