Social Security benefits can go a long way toward providing a comfortable retirement, but many older adults rely too heavily on them. Your monthly checks are meant to replace only about 40% of your pre-retirement income. But almost a quarter of married couples and almost half of unmarried beneficiaries depend on Social Security for at least 90% of their income in retirement, according to the Social Security Administration (SSA).
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And there is a chance that profits will be reduced. The money from payroll taxes is not enough to cover current retiree benefits, so SSA has relied on its trust funds to cover the deficit. Those trust funds are expected to run out by 2034, at which point SSA will only be able to pay approximately 76% of projected benefits. In other words, your monthly checks could be cut by almost 25% if Congress doesn’t find a solution relatively soon.
Because Social Security benefits may not be the safest form of retirement income at this time, it is more important than ever to build a healthy retirement fund. And there is one particular type of investment that can help ensure that your years of service are financially secure.
Balancing risk and reward when investing
While investing for retirement, you’ll want to be aggressive enough to get relatively high rates of return, but safe enough not to risk losing your life savings if the market worsens.
That can be difficult, but there is one type of investment to make it a little easier to balance risk and reward: index funds.
Index funds are large groupings of securities that track a certain index, such as the S&P 500 or the Dow Jones Industrial Average. Since you can’t invest in indices, investing in a fund that mimics the performance of an index is the closest you can get. So, for example, if you invest in an S&P 500 index fund, you are investing in the 500 companies that make up the S&P 500.
One of the most notable proponents of index funds is world-renowned investor Warren Buffett. During Berkshire Hathaway’s annual shareholder meeting in May, Buffett noted that “for most people, the best thing to do is to own the S&P 500 index fund.”
The advantages of index funds
There are two main advantages to an index fund. First, your investments instantly diversify. You are investing in dozens or even hundreds of stocks at once. Diversification is key to building a healthy retirement fund because if some of the stocks in your index fund don’t perform well, you’re likely to see no drastic losses.
Of course, if the entire stock market falls, as we saw earlier this year, your index fund is likely to decline in value as well. But the second advantage of index funds is that because they track indices, they are more likely to recover from recessions.
Indices like the S&P 500 are solid representations of the overall stock market. So if the market falls, the S&P will also fall. But historically, the stock market has recovered from every slump, no matter how dire. That means indices like the S&P 500 will recover, and so will your index funds.
Are Index Funds Right for Everyone?
The downside to index funds is that they are just average. Because they tend to follow the market, you won’t see explosive short-term gains like you would with individual stocks. But for many people, the average is good enough. You may not see your earnings soar each year in an index fund, but it’s also limiting your risk.
However, if you are looking to beat the market and maximize your investments, you may want to choose individual stocks. There is nothing wrong with this approach, and it can be a smart way to save. But it takes a lot of time and commitment because you will need to research every stock you invest in to make sure it is a strong company that works well in the long term. It can also be expensive, as you should aim to invest in at least 10 to 15 different stocks to make sure you’re diversifying your portfolio properly.
For those who want to take a practical approach, investing in individual stocks may be the right option. But if you’re looking for a less research-intensive way to invest, “set it up and forget it,” index funds might be your best option. You may not see lucrative earnings from year to year, but slow and steady often wins the retirement race.
