The Case for the S&P 500 in Long-Term Portfolios

The S&P 500 index, which tracks the performance of the 500 largest U.S. publicly traded companies, is one of the most popular and effective vehicles for long-term investing. There are several compelling reasons why the S&P 500 should be a core holding in portfolios with a long time horizon:

U.S. economic growth: The S&P 500 represents about 80% of U.S. stock market capitalization. As such, it provides broad exposure to the growth and profitability of the U.S. economy over time. Historically, U.S. GDP has been strong, expanding by 3.4% in the fourth quarter of 2023 compared to the previous quarter. This indicates that the economy maintained strong growth momentum towards the end of 2023. So the stocks have delivered strong returns, with the S&P 500 averaging annual gains of about 10% over the long run.

Diversification: The fund provides instant diversification across 500 U.S. companies spanning all major economic sectors. This diversification reduces company-specific and industry-specific risk compared to a more concentrated portfolio. Diversification is a proven way to optimize risk-adjusted returns.

Low costs: S&P 500 index funds and ETFs charge very low expense ratios, often less than 0.1% annually. In contrast, actively managed mutual funds that try to beat the market typically charge 1% or more annually. Those higher fees eat into returns over time. The low costs of S&P 500 index funds allow investors to keep more of the market's returns.

Simplicity: Investing in an S&P 500 index fund offers a straightforward, stress-free way to gain broad exposure to the U.S. stock market. There's no need to research and select individual stocks or to rebalance the portfolio regularly. An S&P 500 index fund automatically tracks the market, allowing you to focus on other aspects of your investment strategy.

Favorable risk/return profile: The S&P 500 has historically delivered attractive returns relative to its volatility. While not immune to bear markets, its diversification and representation of the broad U.S. economy have allowed it to recover from downturns and reach new highs over time. This risk/return profile makes it suitable as a core long-term holding. From 1950 to 2022, the S&P 500 yielded an annualized average return of ~11.19%

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However, it's important to note that while the S&P 500 offers many benefits, some investors may still prefer individual stocks if they enjoy analyzing companies, want to find outperformers or have the time and skills to manage a stock portfolio actively. This case study aims to help Build Your Own Index Fund.

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