What is the best way to invest in stocks without any experience? Get started with this ETF.

So you’re ready to invest in stocks, but you’re new to the stock market. You have very little experience with this and your confidence level is low. That’s ok. There is one option that even the most novice of investors can buy well. This option is an exchange traded fund (ETF).

ETFs are similar to mutual funds, but are more accessible to the average investor and trade more like stocks. There are a lot of options to choose from and many of them will serve you well. For first-time investors, there is one ETF in particular worth exploring first. It’s a great one for beginners, but also works well for more experienced investors. Even Warren Buffett likes it!

The one I have in mind is a simple, tracking index fund S&P 500. It’s called Vanguard S&P 500 ETF (VOO 0.05%). Here’s why it works well for beginner investors.

Image source: Getty Images.

Why an S&P 500 index fund?

To understand what makes this ETF great, it helps to first understand what an index is and why you might want to invest in a fund that tracks it. Indices are lists of stocks and/or holdings grouped based on specific criteria. For example, the S&P 500 requires a company to have a market capitalization of at least $15.8 billion, be based in the US, be structured as a corporation and at least 50% of its outstanding shares must be available for public trading. They must also report positive earnings in the most recent quarter. That means S&P 500 companies tend to be some of the largest and most powerful companies in the world.

Index funds are made up of holdings that (roughly) mirror the index it tracks. Indices track all kinds of asset classes, and some asset classes perform better than others over the long term. For example, stocks as a group tend to outperform other groupings. When tracking the returns of various asset classes between 1802 and 2021, Wharton Business School professor Jeremy Siegel noted in his book Long term stocks that the annualized nominal return was:

1. Stocks: 8.4%
2. Bonds: 5%
3. Treasury Bills: 4%
4. Gold: 2.1%
5. US Dollar: 1.4%

As already mentioned, the S&P 500 index tracks about 500 of the largest companies in America, holding shares in all of them. The S&P 500 has performed well over a long period of time, with average annual total returns of more than 10% for decades. The ETF’s return closely tracks the index’s returns (less ETF-adjusted management fees). Better yet, index funds tend to outperform actively managed mutual funds. Over the past 15 years, the S&P 500 has outperformed a whopping 88% of the large-cap mutual funds under management, and has outperformed by 87% over the past decade.

Because an S&P 500 index fund tracks more than 500 companies, it also provides instant diversification. The S&P 500 includes stocks representing nearly every sector of the economy and tracks growth stocks as well as dividend-paying stocks. The S&P 500’s dividend yield currently averages 1.3%.

Meet the Vanguard S&P 500 ETF

As already mentioned, ETF returns are affected by management fees. The Vanguard S&P 500 ETF is exceptional in part because its minuscule expense ratio (annual fee) is just 0.03%. A $10,000 investment in the ETF would include a very affordable $3 annual fee.

This fee is generally taken out of the ETF’s annual return. And this return is where this fund really shines. Past performance is no guarantee of future results, but the average annual gain (total return) over various time frames for the Vanguard S&P 500 ETF shows that this fund has performed solidly since its inception in September 2010:

• Last year: 27.8%
• Last three years: 9.6%
• Last five years: 15.1%
• Last 10 years: 13%

These are solid returns. Over longer periods, the S&P 500 has averaged annual returns close to 10% (when adjusting for inflation). So a new investor should not expect an average of 13%, although that could happen. Even at a conservative annual return of 8% (compounded), the results are enviable:

Data source: calculations by author. Note that the figures represent a compounded return on investment.

Clearly, an index fund may be all you need to amass a fat nest egg for retirement.

Here are the top 10 holdings of the Vanguard S&P 500 ETF as of mid-September:

Data source: Vanguard.com. Starting July 31, 2024.

You may notice that the list above includes all of the Magnificent Seven: Apple, Microsoft, Alphabet parent Google, Amazon, Nvidia, meta platform parent Facebook, and Tesla. Anyone who wants to own all of these amazing performers can quickly own a piece of them through an ETF like Vanguard’s.

Even if the Vanguard S&P 500 ETF isn’t right for you, investing in something should be a priority

The Vanguard S&P 500 ETF is a solid contender, but it’s not the only ETF. Several others also follow the S&P 500. We should all plan for retirement and save and invest for it to create additional future income. Social Security will not be enough for most of us to live on in retirement (and was never intended to be our only source of income).

Start soon, too, because the price of procrastination is high.