Is Investing In Just The S&P 500 Enough?

September 05, 2018

One thing I often hear out in the world is that in order to grow your money, all you really need to do is just invest in an S&P 500 Index fund. This is a typically low cost mutual fund that invests in the stocks of 500 of the largest companies in the US, in proportion to how their stock price performs.

Like most index funds, it has outperformed the majority of actively managed funds that invest in similar companies, and this one fund strategy has also been promoted by Warren Buffett. It’s certainly better than trying to time the market, pick a few individual stocks, invest in high-fee funds, or stay in cash over long time periods. So what’s not to like?

A lack of diversity in the companies

The main problem is that the S&P 500 index isn’t as diversified as it may seem to be. While it does include 500 companies, it doesn’t include international or small cap stocks, both of which have had long periods of time where they’ve outperformed the S&P 500. It also doesn’t include any bonds or cash, which can help reduce risk, or real assets, which tend to do well during inflationary periods.

If you’re going to invest in an S&P 500 index fund, consider adding in funds that invest in other asset classes like international and small cap stocks too. You might also want to include bonds and cash, depending on your time frame and risk tolerance, and even some real assets. If you’re not sure how much to put in each asset class, here are some options to consider:

Alternatives to give you more diversification

Target date funds composed of index funds: Since they’re composed of index funds (typically including the S&P 500), these funds are low cost. But as target date funds, they’re also much more diversified and are designed to be a “one stop shop” that automatically become more conservative as you approach the target retirement date. All you need to do is pick one fund (generally the one with the year closest to when you plan to retire). Then “set it and forget it.”

Total market index fund: If you want to stick with all stocks, a total market index fund allows you to invest in just about all the stocks in the world. Just be aware that these funds tend to weight the stocks based on market capitalization so small cap stocks will make up a very small percentage of the fund. They also tend to be slightly more expensive than buying index funds that focus on each area of the market (large US, small US, and international).

Use a robo-advisor or model portfolio: If you want to diversify beyond stocks but want something more customized to you, you may want to consider a robo-advisor that recommends a portfolio for you based on your time horizon and risk tolerance. These programs generally use low cost index funds and are often available at no additional cost in employer-sponsored retirement plans or for a low fee outside such plans. If you want to avoid those fees, you can choose a model portfolio like one of these “lazy portfolios”, but it won’t be customized to you.

Doing simple slightly better

When it comes to investing, simpler is often better, but it’s not always the best approach. In this case, you could certainly do a lot worse than just investing in an S&P 500 index fund. But you can also do a lot better in terms of diversification with just slightly more effort.