Exchange-traded funds, or ETFs, provide investors with the diversification of a mutual fund and the convenience and accessibility of a stock. Currently, there are more than 3,000 ETFs available in the U.S., and in 2022 alone, almost 400 have launched -- which is just off the record pace set in 2021 when 438 launched, according to Morningstar.
With so many options, including a growing number of actively-managed funds, there are ETFs available for every style, sector, or investment objective. In that sense, they are also like stocks. And just as you can retire a millionaire with a portfolio of stocks, you can achieve the same goal with ETFs alone. But just as it does with stocks, it takes a long-term strategy and commitment. Here are three keys to success.
1. Time in the market
The most important ally you have on the road to retiring a millionaire is time. The longer you have to let your investment grow through the power of compounding, where your returns create their own returns, the more you will be able to accumulate. Even just a few years can make an incredible difference in the long run.
Let's look at the difference between 20 and 30 years in the market. If you invested $20,000 in a portfolio that gained 10% on an annual basis, which is roughly the long-term average for the S&P 500, that investment would grow to about $134,000 after 20 years. And that's by doing nothing other than letting your returns compound annually. If you let it grow for 30 years, that $20,000 would grow to about $349,000. Again, that's without making any additional contributions. So, the extra 10 years allowed you to more than double your money.
Image source: Getty Images.
Now say you are in your 20s and have 40 years until retirement. Using that same scenario, you'd have $905,000 -- almost a million. That is the power of time in the market and compounding.
2. Invest wisely and diversify
ETFs, by their very nature, are more diversified than individual stocks, because they are baskets of stocks that typically track an index or some other benchmark. But when the index or benchmark is a particular sector (like technology or energy) or investment style (large-cap growth or income-focused), diversification is limited.
However, ETFs make it far easier to build a diversified portfolio that does include an adequate mix of investment types. Whereas the typical, well-diversified stock portfolio for a beginner might include 10 to 30 stocks, starting off, you could probably invest in three to five ETFs.
If you have a long time until you reach retirement, one of those investments should be an aggressive growth ETF. While aggressive growth funds might be subject to more volatile short-term swings, over time, they have generally produced the best long-term returns.
One of the best examples is the Invesco QQQ, which tracks the tech-heavy Nasdaq-100 index. Over the last 20 years, it has posted a 13.5% annual total return.
You might want to balance that out with an ETF that tracks the S&P 500 to get large-cap exposure, along with perhaps an ETF that tracks mid- or small-cap stocks for additional diversification. The chart below shows the 20-year annual total returns of a variety of indexes and investment styles.
Data by YCharts.
3. Patience and commitment
The third key to building a million-dollar portfolio is to have patience and a long-term commitment to growing it. While it may be tempting to trade out of one ETF into another when the market is down, doing so only locks in your losses and makes you lose out on capital appreciation when the market inevitably turns.
As the chart above shows, the long-term returns for most of the indexes range from 8% to 14%, so it's important to be patient. Also, keep in mind that bull markets have historically lasted longer than bear markets.
The commitment part comes from regularly investing in your portfolio. As previously mentioned, time in the market is a huge factor in growing your portfolio, but consider what a regular $100 investment can also do.
Using the hypothetical above, an initial $20,000 investment in an ETF that averaged a 10% return for 20 years, plus an extra $100 invested each month, would reach about $207,000 after 20 years. After 30 years, in the same scenario, you would have $557,000. If you had a 40-year time horizon, that $20,000 initial investment combined with $100 monthly contributions would grow to almost $1.5 million.
So, it is definitely possible to retire a millionaire on ETFs alone, but it takes time, a good strategy, and a long-term commitment.
Dave Kovaleski has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Vanguard Index Funds - Vanguard Total Stock Market ETF. The Motley Fool has a disclosure policy.
