When you really boil it down, the most important thing to know about investing is how valuable time is. There really is no other factor that is more important to growing your wealth than starting early and investing for the long term. That is due to the power of compounding.
That said, the idea of increasing your retirement nest egg by a factor of 10 is not that complicated. You need a good exchange-traded fund (ETF) and time -- 20 years makes for a nice, long runway to let your investment do its work. If you have those two things, you should be able to grow your retirement savings by a factor of 10 in 20 years. Here's how.
Find a good ETF
While you could certainly grow your retirement portfolio through the investments in your 401(k) or a portfolio of individual stocks, ETFs are about as uncomplicated as it gets.
As a quick primer, ETFs are baskets of stocks that trade like individual stocks on an exchange. They typically mirror an index, like the or Nasdaq Composite. But there are literally thousands to choose from, and you can get ETFs that track a particular industry or sector; an investment style like growth or value; or stocks by market cap. You can also get an ETF that focuses on dividend payers or rely on actively-managed ETFs that are run by a portfolio manager.
One of the major benefits of an ETF is that it represents a basket of stocks. Some are more diversified than others like a toal-market ETF that encompasses every stock in a large index. On the other hand, a sector ETF would obviously be less diversified, as it focuses on just one piece of the economy. But even that would offer more diversification than a single stock. While it might typically require at least 25 individual stocks to diversify a portfolio, you could achieve that with a single ETF.
And in the interest of keeping this simple, let's run with this idea of a single ETF investment and see how it can help grow your nest egg over time. As you are looking 20 years out, you have the time to weather short-term fluctuations in the market, like we have seen in the past few years with two bear markets, a bull market, and whatever it is that we're experiencing right now.
But when you consider long-term trends, bull markets not only have historically lasted longer than bear markets; they have also generated significantly higher returns than bear markets have produced in losses. That's why, over time, the S&P 500 has had an average annual return of about 10%.
The S&P 500 is the market benchmark and tracks the performance of 500 of the largest companies trading in the U.S. But with a 20 year investing horizon, you can consider a growth-oriented ETF as growth funds have historically outperformed value funds and large-caps over longer periods. So, for the purpose of this hypothetical, we'll look at one of the top growth ETFs on the market, the Technology Select Sector SPDR ETF (XLK -1.51%).
The power of time
While there are many excellent growth ETFs out there, the Technology Select Sector SPDR ETF stands out for its strong returns, low cost, and long track record as one of the first technology-focused ETFs.
The fund tracks the Technology Select Sector Index, which includes technology stocks within the S&P 500. Specifically, it includes companies from technology hardware, storage, and peripherals; software; communications equipment; semiconductors and semiconductor equipment; IT services; and electronic equipment, instruments, and components. It is a concentrated group of about 65 stocks with Microsoft, Apple, and Nvidia making up the three largest holdings.
Technology stocks have dominated over the past 20 years and will likely outperform over the next 20 years with the world increasingly going digital and new advances like artificial intelligence (AI) emerging.
Data by YCharts.
If you go back over the last 20 years as of July 26, this ETF has posted an average annual return of 12.2% and an average total return of 13.8% (with dividends and distributions reinvested).
So if this fund averaged a similar 13% annual return over the next 20 years, an initial investment of $20,000 would grow to over $230,000 in that time. With the same inputs and just 10 years in the market, you would only have $68,000, or less than a third of the 20-year total. That illustrates the power of time -- and compounding -- as the returns and reinvested dividends grow on top of each other.
Your eventual nest egg could grow even larger if you continue to add to your investments over time. Just an extra $50 per month ($12,000 in additional contributions over 20 years) in the same scenario above would grow your total savings to about $282,000.
This is a rather encouraging but simple example. In reality, there is no guarantee the Technology Select Sector SPDR ETF delivers the same level of returns in the next 20 years as it has in the previous 20. Someone preparing to retire at year 20 would also want to consider periodically rebalancing their portfolio as their retirement draws closer to reduce their risk exposure and volatility.
However, the core takeaway remains: Even a single investment in a growth-focused ETF could multiply your retirement savings ten-fold over the long-term.
Dave Kovaleski has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Apple, Microsoft, and Nvidia. The Motley Fool has a disclosure policy.
