The short answer to what happens if you invest $500 a month is that you'll almost certainly build wealth over time. In fact, if you keep investing that $500 every month for 40 years, you could become a millionaire. More than a millionaire, in fact.
Investing is about buying assets you believe will increase in value. I'll admit, I was nervous about the idea of investing for the longest time. I thought it was best left to the pros on Wall Street, but I was wrong. In fact, there are many ways individuals can invest without setting foot on a trading floor.
That doesn't mean buying or selling individual stocks willy-nilly. Researching and picking stocks does take time and isn't for everybody. But there are investment strategies that don't involve scouring the financial news. For example, you might open a brokerage account and put money into index funds, mutual funds, or ETFs to get access to a mix of assets in one fell swoop.
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What happens when you invest $500 a month
Whether we're talking about $500 or $50 a month, the magic of consistent investing is that compound interest works in your favor over time. You're essentially using your gains to generate more money. Depending on the returns you earn, the combination of time and compound interest can be powerful.
The table below shows how different average returns on a $500 a month investment might work out over the decades. It may feel like a lot to take in, but it's a great way to see how your wealth-building might pan out. For me, there are two big takeaways:
- When it comes to returns, even a couple of percentage points can make a huge difference to your portfolio over time.
- The longer you contribute to your portfolio and let your money work for you, the better.
| Rate of return | 10 years | 20 years | 30 years | 40 years |
|---|---|---|---|---|
| 4% | $72,000 | $178,700 | $336,500 | $570,200 |
| 6% | $79,000 | $220,700 | $474,300 | $928,600 |
| 8% | $86,900 | $274,600 | $679,700 | $1,554,300 |
| 10% | $95,600 | $343,700 | $987,000 | $2,655,600 |
Source: Author's calculations. Approximate values.
This table does not factor in inflation or the fact that we're talking about average returns. Inflation is one of the arch enemies of wealth-building, because it means your money won't go as far. The ideal is that your investments outpace inflation, so you still come out ahead.
How to invest $500 a month
The good news is that returns of 8% or even 10% are achievable for long-term retail investors. Sure, there may be years when your investments perform well and others when your portfolio declines. But over 20 or 30 years, those short-term fluctuations can even themselves out.
Choose the right fund types
You don't have to take big risks to get decent returns. We touched on different types of funds at the start, so here's a quick breakdown:
- Index funds: Index funds are baskets of stocks that track a specific index, such as the S&P 500. Over the past three decades, the S&P 500 index has generated an annual compound average annual growth rate of over 10%.
- ETFS or exchange-traded funds: These are very similar to index funds. Many ETFs also track specific indexes, but there are differences in how they are traded and how the taxes work.
- Mutual funds: As the name suggests, actively managed mutual funds have a fund manager who chooses what stocks to buy.
If you're trying to maximize your returns, pay attention to fees, also known as expense ratios. Bear in mind that mutual funds often charge higher fees to cover the cost of managing the fund. This is only worth it if the fund generates enough returns to cover that cost. In contrast, the annual fees on index funds and ETFs are often very low. For example, several of the best low-cost index funds have expense ratios of 0.02% or 0.03%.
Build a diversified portfolio
In addition to stock market investments, you might also look to add bonds and other assets such as real estate to your portfolio. Bonds tend to generate lower returns than stocks, but are regarded as lower risk. Without getting too technical, if you buy a bond, you're basically lending money to an organization or government and you'll get paid interest on that debt.
The trick is to find the right mix of assets to suit your risk tolerance, and that will almost certainly change with time. You might shift to lower-risk assets as you're nearing retirement, for example. What matters is to start with a plan that suits your circ*mstances today. A robo-advisor (or real-life financial advisor) might be able to help you get the balance right. Robo-advisors can also regularly review your portfolio and automatically rebalance according to your preferences and even potentially lower your tax bill.
Use tax-advantaged accounts
If you're saving that $500 a month for your retirement, see if you can boost your contributions by reducing your taxes. One common route is a company 401(k) plan. If your company has one and will match your contributions, find out how you can get involved. Not only can you get tax breaks, but the employer match will mean there's more money working for you.
If a 401(k) isn't an option, find out what type of IRA might suit you best. A traditional IRA could mean you lower your tax rate now as you contribute pre-tax income. With a Roth IRA, you'd pay taxes today but you'd be able to withdraw that money -- plus any earnings -- tax free later in life.
Bottom line
Sadly, this is not the place for a crash course in investing. If that's what you're after, check out The Motley Fool's guide on how to invest money. For now, the biggest takeaway is that investing $500 a month can be a fantastic way to build wealth. And the sooner you get started, the better.
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