2 Reasons to Invest in an S&P 500 ETF -- and 1 Smart Reason to Avoid It

Investing in the stock market can be daunting at times. There are countless stocks to choose from, and if you invest in the wrong places, you could potentially lose a lot of money.

Exchange-traded funds (ETFs) can be a simpler and more affordable way to invest, making them perfect for beginners or those looking for a low-effort investment. An ETF is a basket of securities bundled together into a single investment, meaning that by investing in just one share of an ETF, you're actually investing in dozens or hundreds of stocks at once.

The S&P 500 ETF tracks the S&P 500 (SNPINDEX: ^GSPC) index itself, so it includes the same stocks as the index and aims to mirror its performance. There are a couple of good reasons to invest in this type of ETF, as well as one reason you may want to avoid it.

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Image source: Getty Images.

Why invest in an S&P 500 ETF

1. It requires next to no effort on your part

Investing in individual stocks takes a lot of time and energy, and it can be expensive, too. A properly diversified portfolio includes at least 25 to 30 stocks from a variety of industries. You'll need to thoroughly research every company you're considering buying, as well as keep up with the latest news and industry trends to decide whether you should hold or sell your stocks.

With an ETF, all the stocks are already chosen for you, taking all the guesswork out of where to buy. An S&P 500 ETF, specifically, includes roughly 500 stocks across multiple industries, creating an instantly diversified portfolio with a single investment.

Also, the S&P 500 itself only includes stocks from the strongest companies in the U.S. If a company fails to meet the high standards of the index and is removed (and a new stock is added to take its place), your investment will update automatically. That means you don't need to do any of the legwork -- simply invest consistently and let the fund handle everything else.

2. It has a perfect long-term track record

The S&P 500 itself has a decades-long history of recovering from every recession, market crash, or bear market it has ever faced. In fact, research shows that no matter when you invest, you're likely to make money with an S&P 500 ETF -- as long as you keep a long-term outlook.

Experts at Crestmont Research studied the S&P 500's rolling 20-year total returns to determine how often the index earned positive returns. They found that every single 20-year period in the index's history ended in positive total returns. This means that no matter when you had invested, you'd have made money as long as you held your investment for 20 years.

In other words, it's proven harder to lose money in the S&P 500 than it is to make money. While there are never any promises when it comes to the stock market, an S&P 500 ETF is about as close to guaranteed long-term returns as you can get.

Why avoid the S&P 500 ETF

1. It can't earn above-average returns

Perhaps the biggest downside of the S&P 500 ETF is that can't earn higher-than-average returns. It's designed to follow the market, so it's impossible for it to beat the market.

That doesn't mean you can't make a lot of money with this type of investment. But if you were to build a customized portfolio full of high-performing stocks, you could potentially earn far more over time.

Historically, the market itself has earned an average rate of return of around 10% per year. Say, for example, you're investing in an S&P 500 ETF earning a 10% average annual return. In another scenario, say you're investing in individual stocks and earning a slightly higher 13% average annual return. If you're investing, say, $200 per month in both cases, here's approximately how your savings would add up over time:

Number of Years Total Portfolio Value: 10% Average Annual Return Total Portfolio Value: 13% Average Annual Return
10 $38,000 $44,000
20 $137,000 $194,000
30 $395,000 $704,000
40 $1,062,000 $2,433,000

Data source: Author's calculations via investor.gov.

For many people, average returns are a worthwhile sacrifice for the ease and simplicity of an S&P 500 ETF. Not everyone has the time or interest to invest in individual stocks, and that's OK. But if you're serious about building a portfolio that can beat the market, an S&P 500 ETF may not be the best fit for you.

An S&P 500 ETF can be a fantastic choice for those looking for a lower-effort, lower-risk investment that could help you build substantial wealth over time. It won't be the right option for everyone, though, so by considering your goals and preferences, you can decide whether it belongs in your portfolio.

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Katie Brockman has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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