On the surface, it might seem like the S&P 500 would be all you need to retire a millionaire. After all, that index has an incredibly strong long-term track record, is fairly well diversified, and is made up of large, generally financially stable companies. With that line of thinking, you might believe a great lifetime financial strategy would be to simply dollar-cost-average into an S&P 500 index fund until you hit millionaire status. Then, simply retire and sell of shares of that fund when you need spending cash.
The key problem with that line of thinking is that stocks don’t always go up, and indeed, the stock market does crash from time to time. Any retirement plan that relies 100% on stocks is incredibly risky. The key reason is that if you need to sell your stocks when they’re down, you’ll have that many fewer shares to participate in any recovery that follows. Because of that, you’ll need more than just the S&P 500 to retire a millionaire.
Saving years vs. spending years
All that said, you may very well be able to become a millionaire by investing only in the S&P 500. Over the long haul, that index has provided annualized returns somewhere in the neighborhood of 9% to 10%. At an average of 9% returns per year, investing $1,000 per month would get you to millionaire status in just under 24 years. While stock returns are never guaranteed, history shows that regular investments in an S&P 500 index fund could help you become a millionaire within a typical career.
There’s a difference, however, between saving for retirement and using your retirement savings to cover your costs. While you’re actively saving for your retirement, it’s fairly easy to stomach the ups and downs of the market. Indeed, a down market can actually give you the chance to buy more shares while they’re cheap. Once you’re living off your portfolio, however, down markets become a bigger problem.
If you’re relying on your portfolio to cover your costs of living, then every share of stock you have to sell becomes one fewer share that can compound for your longer-term future. When stocks are falling and low, you need to sell that many more shares to raise the same number of dollars. Since your bills are likely due in dollars, having to sell more shares a down market to raise those dollars can force you to quickly run through your portfolio.
This is why an S&P 500 index fund might be enough to let you reach millionaire status by the time you retire but is not enough on its own to support you through retirement. You still need the long-term growth potential from stocks to help cover your longer term expenses, but for your near term needs, you need investments with much higher certainty than stocks.
Cash, CDs, and high-quality bonds — for those near term expenses
When it comes to money you expect to spend from your portfolio within the next five years, you need it invested in places that you can have a much higher certainty of near term outcomes than stocks. That means things like cash, CDs, and high-quality bonds that mature around the time you’ll need the money.
The upside of those types of investments is that they are much more likely than stocks to offer the cash flows they promise on the timings they promise them. That makes them appropriate to consider as assets to have available to cover your near term costs. The downside, unfortunately, is that at today’s low interest rates, their returns are not likely to be able to keep up with inflation.
As a result, you need to be sure you maintain a balanced portfolio. You need enough cash, CDs, and high-quality bonds to cover your near term costs, but also enough in stocks to give you the chance to maintain your purchasing power over time.
Find the right balance for long term success
A five-year buffer of those higher certainty investments provides a reasonable balance point. The ability to spend down your higher-certainty investments gives you enough time to ride out most typical market corrections without having to sell stocks while they’re dropping. On the flip side, keeping the rest of your investments in stocks gives that money the chance to grow. Over time, you’ll want to use the growth in your stocks to replenish the higher-certainty assets you’re spending to cover your costs.
That combination gives you a much stronger likelihood of success over time as a retiree than being invested only in stocks or invested only in higher certainty assets will. It does, however, mean that you will need to continue to monitor and manage your investments even after you retire.
Fortunately, it can be a fairly straightforward process:
- When the stock market is growing about as much as is expected, you sell enough stocks to replenish the higher-certainty assets you are spending to cover your costs.
- When the stock market is growing faster than expected, you sell enough stocks to build your higher-certainty buffer to be able to cover an even longer period of time
- When the stock market is dropping, let your buffer shrink as well — that’s why you’ve given yourself a five-year buffer, after all.
Should you be worried that the market’s downturn could last for an extended period of time, you can use the time your five-year buffer gives you to figure out a way to get your costs down. That can help your buffer last longer and reduce the amount of stock you need to sell to cover those lowered costs.
Get your stocks playing the right role today
An S&P 500 fund makes a reasonable choice for the stock portion of your portfolio, and over time, it should be able to play the role you need it to no matter where you are in that journey. Just be sure to recognize that it’s a better asset for your long-term needs than for your short-term ones and invest accordingly. Make today the day you put your plans in place to invest according to that reality, and you’ll improve your long-term chances for success.