The Federal Open Market Committee (FOMC) is a policymaking body within the Federal Reserve System. It helps the central bank fulfill its dual mandate of maximizing employment and maintaining stable prices. Specifically, the 12 members of the FOMC meet eight times each year to discuss economic data and adjust monetary policy, usually by raising or lowering the federal funds rate, which impacts other rates throughout the economy (e.g., bank loans, credit cards).
Over the last 14 months, the FOMC has aggressively tightened its monetary policy in an effort to stamp out inflation. Officials have approved 10 consecutive rate hikes, raising the federal funds rate at its fastest pace since the early 1980s. Those efforts have indeed caused inflation to cool but also throttled economic growth, and recent turmoil in the banking industry could add momentum to the problem.
The FOMC now expects the U.S. economy to enter a recession before the end of 2023. Fed officials believe the recession will be mild, but some investors will undoubtedly attempt to trade the news by avoiding the stock market until the economy improves. That’s a bad idea.
It makes more sense to invest while the market is down. Here’s why.
Market timing is a bad idea
The stock market is often described as “forward looking” in nature because investors anticipate and react to events before they happen. For example, the S&P 500 fell into a bear market on Jan. 3, 2022, two months before the FOMC imposed its first rate hike. The same thing happens on the other side of a recession.
The stock market generally starts to rebound before economic activity hits bottom. In fact, the S&P 500 started climbing toward new highs before gross domestic product (GDP) hit bottom during every recession in the last 50 years, with only one exception.
During that time, the S&P 500 produced a median return of 41% between the time it hit bottom and the first quarter in which GDP returned to growth. That means investors who sit on the sidelines during the coming recession (assuming the economy is indeed headed for a recession) will likely miss part of the stock market’s rebound. Therein lies the problem with market timing.
The S&P 500 has a perfect track record
The U.S. economy has suffered 17 recessions in the last century, and each was unique in terms of circumstance, duration, and severity. But the S&P 500 has nevertheless maintained a perfect track record. It has never failed to recoup its losses, despite falling sharply on several occasions.
Better yet, the index has produced a positive return over every rolling 20-year period since its inception in 1957, according to Crestmont Research. That means investors who own an S&P 500 index fund are virtually guaranteed to make money given a long enough holding period.
How to invest in the S&P 500
Investors have several good options when it comes to S&P 500 index funds, but the Vanguard S&P 500 ETF (VOO) is especially attractive, given its low expense ratio of 0.03%. That means the annual fees on a $10,000 portfolio would total just $3.
Like its benchmark, the Vanguard S&P 500 ETF tracks 500 large U.S. companies that span all 11 market sectors, representing a blend of value stocks and growth stocks. That diversity makes the ETF a compelling investment option. It mitigates risk by spreading capital across hundreds of stalwart businesses that form the fabric of the U.S. economy, the largest in the world.
The Vanguard S&P 500 ETF’s top 10 holdings are detailed below, along with their weighted exposures:
- Apple: 7.1%
- Microsoft: 6.2%
- Alphabet: 3.4%
- Amazon: 2.7%
- Nvidia: 1.9%
- Tesla: 1.6%
- Berkshire Hathaway: 1.6%
- Meta Platforms: 1.4%
- ExxonMobil: 1.3%
- UnitedHealth Group: 1.3%
Some investors may find index funds boring. They certainly lack the excitement that comes with owning individual stocks, but boring investments aren’t necessarily bad investments. In fact, the opposite is often true. To quote Warren Buffett, “Investors should remember that excitement and expenses are their enemies.”
The Vanguard S&P 500 ETF may be boring, but the index fund still soared 208% over the past decade, so its total return works out to 11.9% annually. At that pace, $150 invested weekly would be worth $136,000 in a decade, $555,000 in two decades, and $1.8 million in three decades. Not bad for a boring investment.
— Trevor Jennewine
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Source: The Motley Fool