Index funds are a great way to passively grow your wealth. They provide an easy way to diversify, and match the return of the market. But how fast do index funds grow?
On average, an S&P Index fund grows at ~10% per year. Using the rule of 72, this means that the index fund will double after ~7 years. Index funds grow at the same rate as their underlying index, so if the index goes up, so does the index fund.
The return of a given index fund depends on the index that it tracks. The 10% figure can also be misleading, as the annual performance can be vastly different. 10% represents the average return, but as you can see below, there can be a lot of fluctuation.
How Fast Do Index Funds Grow?
Index funds track the performance of a select market index. The most common one is the S&P 500, which represents the 500 largest publicly traded companies in the U.S.. Index funds do their best to match the performance of the index that they follow. So if the S&P 500 goes up by 5%, so does the index fund.
The S&P 500 has returned an average of ~10% annually since 1957 (when it adopted 500 stocks into the index). This means that for every $1,000 dollars that you have invested in the S&P 500, on average that dollar would grow $100 each year. This of course would compound, so start with $1,000 in year 0, you’d have $1,100 at the end of the year (+$100), and then $1,210 at the end of two years (+$110). So each additional year would compound into more growth.
Using the rule of 72 (see below), this means your investment would double in around 7 years.
Why this 10% Figure Can Be Misleading
The annual return of the S&P 500 can fluctuate wildly between years:
There are years where the S&P returns almost 40% (1975 and 1995), and there are years where the market can lose almost 40% (2008).
So as much as the average of all the years may be 10%, it’s not a smooth ascent. You can’t expect your money to grow 10% each year, but rather it may grow 20% in one year, then drop by 10% the following (1999-2000).
When you leave your money invested in the index over the long run, the returns will average 10% yearly, but year by year will not. Even over a 5 year time frame (see the blue line), the returns can flucuate.
So the key takeaway is that even though on average the S&P 500 returns 10%, the annual returns likely will be different.
The Annual Return of Other Indexes (Nasdaq, TSX)
The S&P 500 is the most commonly referenced index for market performance, there are some other common indexes that could also be used for index funds.
Nasdaq 100
The Nasdaq is the second largest stock exchange in the U.S. (after the New York Stock Exchange). The Nasdaq 100 represents the 100 largest non-financial companies listed on the stock exchange.
The index has returned ~17.7% on average since 1986:
The Nasdaq 100 has followed similar trends as the S&P 500, but with much larger fluctuations.
Dow Jones
The Dow Jones Industrial Index (commonly known as the Dow Jones, or the Dow) was started in 1886, and is a stock market of 30 prominent companies listed on U.S. stock exchanges . It is maintained by the S&P Dow Jones Indices, which is majority owned by S&P Global.
In the last 50 years, it’s returned an average of ~8.4%.
The Dow returns have been similar to the S&P, though slightly less volatility.
The Rule of 72
When determining how long a value will take to double, the rule of 72 can be used as an approximation.
The rule of 72 states that the time it will take to double is equal to 72 divided by the interest rate. So if you have a return of 10%, your money will double in ~7.2 years (72/10).
This can be a helpful tool when estimating your growth rate with the various index funds.
The Magic of Compounding – Why Your Growth Will Accelerate With Time
As mentioned above, the 10% average return will compound. So if you invest $1,000, after 1 year it will grow by 10%, or $100. Then in the second year, it will increase 10% on the initial amount ($1,000) and the growth ($100), to give growth of $110.
This may not seem like much, but if you leave this over a long time frame, the growth can be unimaginable. For example, if you leave that same $1,000 for 30 years at 10%, here’s the growth:
The 10% annual return on $1,000 will have returned almost 1,800% total to give a total value of $17,450.
So what matters is leaving the money in the market to compound and grow exponentially.
Past Performance Can’t be Used To Predict Future Performance
One thing to highlight is that though these indexes have returned the above averages historically, this is not something that is guaranteed in the future.
Historically, the U.S. stock market has performed well, but there’s no way to guarantee that that continues in the future. This is not to say you shouldn’t invest, but rather to remember that the stock market can fluctuate, and not to lock your sights on the 10% figure. Because as shown above, the annual returns can look very different.
Remember that the market is unpredictable, and will not behave how you expect.
How to Invest in the S&P 500
Now that you know how much index funds will grow, you need to get in on this growth.
If you haven’t already, I’d recommend investing in S&P 500 index funds. Doing so is easy, and you can get started without a lot of capital. You can purchase an index fund that tracks the index and then just watch it grow.
For more information, check out this article: How to Invest in the S&P 500 and get started building your wealth.