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.
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FAQs
Yes. Index funds are a great choice for retirement due to their long-term growth potential, low fees, and diversification.
Can you retire from index funds? ›
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).
Can you live off of an index fund? ›
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.
What are the 4 index funds to retire a millionaire? ›
You can build a powerful, global portfolio with these four Vanguard ETFs: Vanguard Total Stock Market ETF (NYSEMKT: VTI), Vanguard Total International Stock ETF (NASDAQ: VXUS), Vanguard Total Bond Market ETF (NASDAQ: BND), and Vanguard Total International Bond ETF (NASDAQ: BNDX). That's really all you need.
Are index funds better than 401k? ›
The primary con of index funds when in comparison to 401(k) plans is the lack of any tax advantage. Fund purchases are made with after-tax dollars and investors pay taxes on any gains in their holdings, just like normal stock investments. There is also a lack of flexibility in index funds.
Do billionaires invest in index funds? ›
It's easy to see why S&P 500 index funds are so popular with the billionaire investor class. The S&P 500 has a long history of delivering strong returns, averaging 9% annually over 150 years. In other words, it's hard to find an investment with a better track record than the U.S. stock market.
Can you become a millionaire from index funds? ›
Still, there's good news from this chart: With the right investing discipline, a solid index fund and time, there's a good chance you can become a millionaire, even if you understand little about the stock market. In fact, if you follow this plan, it may be difficult to avoid becoming a millionaire.
Is there a downside to index funds? ›
While indexes may be low cost and diversified, they prevent seizing opportunities elsewhere. Moreover, indexes do not provide protection from market corrections and crashes when an investor has a lot of exposure to stock index funds.
Is it wise to only invest in index funds? ›
If you're new to investing, you can absolutely start off by buying index funds alone as you learn more about how to choose the right stocks. But as your knowledge grows, you may want to branch out and add different companies to your portfolio that you feel align well with your personal risk tolerance and goals.
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).
Average Monthly Retirement Income
According to data from the BLS, average 2022 incomes after taxes were as follows for older households: 65-74 years: $63,187 per year or $5,266 per month. 75 and older: $47,928 per year or $3,994 per month.
What is the 4% rule for index funds? ›
The 4% rule says people should withdraw 4% of their retirement funds in the first year after retiring and take that dollar amount, adjusted for inflation, every year after. The rule seeks to establish a steady and safe income stream that will meet a retiree's current and future financial needs.
How long will $4,000,000 last in retirement? ›
Looking to retire on $4 million? If you leave work at 61, the average retirement age as of the latest Gallup data, you'll have more than enough to see you through to a life expectancy of 90 or even 100. Across 29 years, $4 million could equate to a generous $11,494 a month.
What do rich people invest in for retirement? ›
It's not gold, silver, Bitcoin or the stock market — it's real estate.” Cardone said that he keeps 95% of his wealth invested in real estate. “Even when it comes down in value — like right now, all valuations are coming down — my income from the real estate doesn't go down,” he said.
Is $4,000,000 enough to retire at 55? ›
You can probably retire at 55 if you have $4 million in savings. This amount, according to conventional estimates, can reliably produce enough income to pay for a comfortable retirement.
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.
How long should you stay in an index fund? ›
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.
Can you live off index fund dividends? ›
Over time, the cash flow generated by those dividend payments can supplement your Social Security and pension income. Perhaps, it can even provide all the money you need to maintain your preretirement lifestyle. It is possible to live off dividends if you do a little planning.
What are index funds for retirement? ›
Indexes themselves merely track the performance of a group of stocks. Instead, you'll purchase shares of funds that aim to closely match the returns of these trackers. Index fund managers will buy shares of every company listed on the index, or at least a representative sample, to accomplish that goal.
