We all dream of having substantial wealth. For many people, though, the stock market is the golden ticket. In spite of that, investing can be a complex, jargon-filled world filled with endless options.
However, what if we told you that a relatively simple approach could make you a millionaire? Well, it’s possible. Find out how by reading on.
Understanding ETFs
Let’s briefly discuss ETFs before diving into the strategy. An exchange-traded fund (ETF) tracks an underlying index, such as the S&P 500. ETFs are essentially baskets of securities that diversify your risk across multiple companies instead of buying individual stocks, where your investment is concentrated in one company.
Warren Buffett, one of the world’s most successful investors, has often urged index funds to simplify investing. He recommends investing in a low-cost S&P 500 index fund instead of actively managing an investment.
The Power of Compounding and Dollar-Cost Averaging
Two powerful concepts are at the heart of long-term investing: compounding and dollar cost averaging.
- Compounding. According to Albert Einstein, this is the eighth wonder of the world. It is essentially how you earn interest on interest. As time goes on, the growth can become exponential.
- Dollar-cost averaging. This strategy involves regularly investing a fixed amount in a particular investment, regardless of share price. By buying more shares when prices are low and fewer when prices are high, you can reduce the impact of market volatility.
The Single ETF Strategy
Unlike stocks, exchange-traded funds (ETFs) are baskets of securities. From stocks to bonds to commodities, ETFs track various asset classes.
With a low-cost ETF tracking a broad market index (such as the S&P 500), you can achieve diversification without the complexity of picking individual stocks. This strategy is often referred to as “passive investing.”
Why a Single ETF?
- Simplicity. ETFs simplify decision-making and reduce management fees over stock portfolios.
- Diversification. Investing in a broad-market ETF gives you access to hundreds of companies, reducing the risk involved with investing in individual stocks.
- Low costs. Investing in ETFs with low expense ratios allows you to keep more of your returns.
- Automation. You can automate investments to ensure consistent contributions without taking any action.
The Million-Dollar Equation
The following three factors contribute greatly to reaching a million dollars through ETF investing:
- Initial investment. In general, the larger your starting amount, the faster you may reach your goal.
- Contribution amount. You can significantly accelerate your investment growth by making regular contributions.
- Rate of return. Although past performance does not guarantee future results, historical market returns can provide a general benchmark.
Here’s an example. Based on a $10,000 investment contributing $500 per month and a 7% annual return (historical average for S&P 500):
- The amount you could accumulate in 20 years is approximately $547,000.
- Increasing your initial investment, adjusting your contributions, or extending your investment horizon are all possibilities for reaching a million dollars.
ETF Obstacles
Of course, becoming a millionaire is not without its challenges. Your investment journey can be affected by market fluctuations, economic downturns, and personal setbacks. However, it’s important to keep a long-term perspective while making investments.
- Commissions and expenses. Despite their lower expense ratios and trading commissions, exchange-traded funds still incur expenses.
- Underlying fluctuations and risks. An ETF tracks an underlying index, so its performance is tied to its performance. A market downturn can negatively affect the value of an ETF.
- Low liquidity. It may be difficult to buy or sell shares of some ETFs, especially those tracking niche markets, due to low trading volumes.
- Capital gains distributions. You can face tax obligations even if you do not sell your shares if you own an ETF that distributes capital gains.
- Lump sum vs. dollar-cost averaging. The timing of your ETF investment can have a significant impact on returns. It is possible to mitigate market fluctuations by using dollar-cost averaging.
- Leveraged ETFs. These ETFs can increase returns by using derivatives, but they can also be extremely volatile and risky.
- ETFs vs. ETNs. While similar to ETNs, they are backed by the issuer, not by assets. As such, credit risk is associated with them.
- Reduced taxable income flexibility. Unlike mutual funds, ETFs typically generate taxable income, which limits tax-loss harvesting opportunities.
- Underlying value. Due to market conditions, the ETF’s price may differ from its net asset value (NAV).
- Issues of control. An ETF’s underlying holdings are limited in control by investors.
Mitigating Risks
In order to meet these challenges, consider the following:
- Diversification. To reduce risk, spread your investments across different ETFs.
- Research. Before investing, make sure you are familiar with the ETF’s underlying assets, fees, and risks.
- Long-term perspective. Instead of focusing on short-term changes in the market, aim for long-term goals.
- Tax efficiency. You may want to consider ETFs or investment accounts that are tax-efficient.
- Rebalancing. Make sure you review your ETF portfolio periodically to determine if it needs to be rebalanced.
Is It For Everyone?
For many investors, the single ETF strategy is the right approach. Some people, however, may not be able to make use of it. As such, before making a financial commitment, consider the following;
- Risk tolerance. Investing in a conservative strategy might be better if you have a low-risk tolerance.
- Time horizon. Investors with short-term investments may experience increased volatility.
- Financial goals. It is important to consider your specific financial goals when selecting an investment strategy.
The Million-Dollar Question
By investing in a single ETF, how long does it take to become a millionaire? The answer depends on several factors, including your investment amount, the ETF’s performance, and your investment timeframe. However, it is possible to accumulate substantial wealth by consistently investing over several decades based on historical market returns.
Disclaimer: While investing in a single ETF can be a straightforward approach, becoming a millionaire through any investment strategy requires time, market conditions, and a significant initial investment. There is no guarantee that future results will be the same as past results. Before investing, it’s important to conduct thorough research or consult with a financial advisor.
FAQs
What is an ETF?
Exchange-traded funds (ETFs) track underlying indices, commodities, or baskets of assets. Similar to individual stocks, investors can buy and sell shares on a stock exchange.
How does investing in a single ETF work?
If you invest a fixed amount of money in an ETF over a long period, you benefit from dollar-cost averaging and compound growth. Over time, this strategy allows your investments to grow while reducing market volatility.
Is it really possible to become a millionaire by investing in just one ETF?
It’s not guaranteed, but based on historical data, the S&P 500 ETF is highly likely to generate substantial wealth over decades. However, remember that past performance is not indicative of future performance.
Which ETF is best for this strategy?
Due to their historical performance and diversification, S&P 500 index funds like the Vanguard S&P 500 ETF (VOO) are popular investments. However, you should consider your risk tolerance, investment objectives, and time horizon before choosing an ETF.
How much should I invest?
To determine how much to invest, you need to consider your financial situation and goals. For example, if your income increases, you can increase your savings amount. Over time, even small, consistent investments can add up.
Can I withdraw money from my ETF investments?
ETF investments can be withdrawn anytime, but doing so may hurt your long-term goals. However, during market downturns, you should avoid withdrawals only when necessary.
Image Credit: Markus Winkler; Pexels
