How to Make Money with Index Funds (2026): Compounding & Dollar-Cost Averaging

There’s a Warren Buffett quote that gets repeated so often it’s almost lost its power: “A low-cost index fund is the most sensible equity investment for the great majority of investors.”

Buffett didn’t say that casually. He backed it with a million-dollar bet — wagering that a simple S&P 500 index fund would outperform a collection of hedge funds chosen by investment professionals over a ten-year period. He won convincingly. The index fund returned 125.8% cumulatively. The hedge funds averaged 36%.

That bet is the single best argument for index fund investing. Not because index funds are exciting or flashy — they’re the opposite. They work precisely because they’re boring, cheap, and automatic.

But boring doesn’t mean effortless. And understanding how index funds actually generate returns — the mechanics, the math, the timeline — is what separates people who build genuine wealth from people who invest $500, check the balance three months later, feel underwhelmed, and quit.

So let’s walk through it properly: how index funds work, how the money compounds, what you can realistically expect, and who should (and shouldn’t) use this strategy.

First — This Is Important…

Hey, my name is Mark.

After 15+ years building income online, index fund investing is something I genuinely respect — and use personally for long-term wealth building. But I’ll be direct: if you’re starting with limited capital and need income in the next year, index funds aren’t your answer. They’re your 20-year plan.

For near-term income, the model I rely on is local lead generation. I build simple websites that rank in Google and generate leads for local businesses. Each site pays $500–$1,200/month, recurring, with 92–97% margins. That cash flow is what funds my long-term investments.

Go here to see the exact system I use to do this

Now — here’s how index fund wealth building actually works.

What Index Funds Are

An index fund is a type of investment fund — either a mutual fund or an ETF — designed to match the performance of a specific market index. It doesn’t try to beat the market. It tries to be the market.

The most well-known index is the S&P 500, which tracks the 500 largest publicly traded companies in the United States. When you buy an S&P 500 index fund, you’re essentially buying a tiny piece of Apple, Microsoft, Amazon, Nvidia, Alphabet, JPMorgan, and 494 other companies — all in one purchase.

Other common indexes include the Total U.S. Stock Market (which includes roughly 3,500+ companies of all sizes), international developed markets, emerging markets, and bond markets. Each has a corresponding index fund you can buy.

The fund is “passively managed,” meaning a computer tracks the index and automatically adjusts holdings to match it. There’s no fund manager making judgment calls about which stocks to buy or sell. This is why fees are so low — often 0.03–0.10% annually compared to 1.00–2.00% for actively managed funds.

How Index Funds Generate Returns

Your money grows through two mechanisms, both working simultaneously.

Market Appreciation

As the companies inside the index grow their revenues, earnings, and market value, the index rises — and your fund’s value rises with it. When the S&P 500 gains 12% in a year, your S&P 500 index fund gains approximately 12% minus the tiny expense ratio.

You don’t need to pick the winning stocks. The index does it automatically. As successful companies grow larger, they take up a bigger percentage of the index. As struggling companies shrink, they become a smaller portion — or get removed entirely and replaced by growing ones.

This is the self-correcting beauty of index investing. You always hold the winners because the index constantly reweights toward them. Apple wasn’t even in the top 10 of the S&P 500 twenty years ago. Now it’s often the largest holding. The index adapted without you doing anything.

Dividends

Many companies in the index pay dividends. The index fund collects these and distributes them to you, usually quarterly. For the S&P 500, the dividend yield typically runs 1.3–2.0%. You can take the cash or reinvest it automatically.

Total return = price appreciation + dividends. The S&P 500’s historical average of roughly 10% annually includes both components. Price appreciation has contributed about 7% and dividends about 3%, though the mix varies by decade.

The Power of Compounding: Why Time Matters More Than Timing

Compounding is the engine of index fund wealth. It’s also the reason this strategy requires patience that most people underestimate.

Here’s how it works in plain terms: your returns earn returns. In year one, you earn a return on your initial investment. In year two, you earn a return on your initial investment plus year one’s gains. In year three, you earn a return on everything accumulated so far. This snowball effect accelerates dramatically over time.

Compounding math with a $10,000 lump sum at 9% average annual return:

Year	Portfolio Value	Total Gain
1	$10,900	$900
5	$15,386	$5,386
10	$23,674	$13,674
15	$36,425	$26,425
20	$56,044	$46,044
25	$86,231	$76,231
30	$132,677	$122,677

Notice the acceleration. In the first 10 years, you gained $13,674. In the next 10 years (years 10–20), you gained $32,370 — more than double, even though you added no new money. In the final 10 years (years 20–30), you gained $76,633. The same $10,000 earned more in its last decade than in its first twenty years combined.

That’s compounding. And it’s why starting early — even with small amounts — matters enormously.

Dollar-Cost Averaging: The Strategy That Removes Emotion

Most people don’t have $10,000 sitting in a bank account ready to invest. They have $200–$500 per month from their paycheck. Dollar-cost averaging (DCA) is the strategy built for this reality.

DCA means investing a fixed amount at regular intervals — regardless of whether the market is up or down. You buy more shares when prices are low and fewer shares when prices are high. Over time, this averages out your purchase price and eliminates the impossible task of “timing the market.”

Why this works psychologically: Human nature pushes us to buy when markets are soaring (excitement) and sell when markets crash (fear). Both are exactly wrong. DCA automates the correct behavior: buying consistently, especially during downturns when prices are cheap.

DCA in action: $500/month into an S&P 500 index fund at 9% average annual return:

Timeframe	Total Contributed	Portfolio Value	Growth Beyond Contributions
5 years	$30,000	~$37,500	~$7,500
10 years	$60,000	~$97,500	~$37,500
15 years	$90,000	~$189,000	~$99,000
20 years	$120,000	~$334,000	~$214,000
25 years	$150,000	~$560,000	~$410,000
30 years	$180,000	~$918,500	~$738,500

At the 20-year mark, your portfolio has gained more from compounding ($214,000) than you’ve contributed from your own pocket ($120,000). By year 30, the market has generated over $738,000 in growth on $180,000 of contributions. That’s the compounding snowball in practice.

Historical Return Averages: Setting Proper Expectations

The S&P 500’s long-term average return of ~10% annually is one of the most cited numbers in all of investing. But understanding what “average” really means prevents dangerous misconceptions.

What “10% average” actually looks like year to year: The market almost never returns exactly 10% in a given year. It swings between gains of 20–30% and losses of 10–40%. The average emerges over long periods, not in any single year.

Between 1926 and 2024, the S&P 500 delivered a positive annual return in roughly 73% of calendar years and a negative return in 27%. In other words, about one out of every four years, your portfolio declines. Some years it declines significantly.

Worst-case scenarios over different holding periods:

Holding Period	Worst Historical Return (annualized)	Best Historical Return (annualized)
1 year	-43.3% (2008)	+52.6% (1954)
5 years	-2.4% per year	+28.6% per year
10 years	-1.4% per year	+20.1% per year
20 years	+6.5% per year	+17.9% per year
30 years	+8.5% per year	+14.8% per year

The critical insight: over any 20-year rolling period in the history of the S&P 500, the worst annualized return was still a positive 6.5% per year. Over 30-year periods, no investor who held through the entire period lost money — not once.

This is why the index fund strategy works: if you commit to a long enough timeframe and don’t sell during downturns, the historical probability of positive returns approaches certainty. The risk isn’t in the market — it’s in your behaviour.

Long-Term Wealth Accumulation: The Realistic Picture

Let’s map out what an actual index fund wealth-building journey looks like at different income levels, assuming a 9% average annual return.

Starting from zero, investing monthly:

Monthly Investment	10-Year Value	20-Year Value	30-Year Value
$100	~$19,500	~$66,800	~$183,700
$250	~$48,750	~$167,000	~$459,250
$500	~$97,500	~$334,000	~$918,500
$750	~$146,250	~$501,000	~$1,377,750
$1,000	~$195,000	~$668,000	~$1,837,000

If you can invest $500/month for 30 years, you’ll likely retire with close to a million dollars. At $1,000/month, you’re looking at nearly $1.8 million. These aren’t fantasy projections — they’re based on the same historical average that has held for almost a century.

The challenge isn’t the math. The math is beautiful. The challenge is finding $500 or $1,000 per month to invest consistently for decades while also living your life. That’s where income matters — and why I always tell people: if you don’t have surplus income to invest, the first priority is building an income source, not optimizing an investment strategy.

Risks of Index Fund Investing

Index funds are the lowest-risk way to invest in the stock market, but they’re not risk-free.

Market downturns. Your portfolio will decline during recessions and bear markets. The S&P 500 lost approximately 50% during 2007–2009 and 34% in March 2020. If you invested $200,000 before the 2008 crash, your portfolio dropped to roughly $100,000. It recovered — eventually. But watching six figures evaporate tests even the strongest conviction.

Sequence of returns risk. If you’re withdrawing money (in retirement), a market crash in your early retirement years can permanently damage your portfolio. This is less about index funds specifically and more about retirement planning — but it’s relevant to anyone investing toward eventual withdrawals.

Inflation. The ~10% average return drops to ~7% after inflation. Over long periods, inflation steadily erodes purchasing power. Index funds have historically outpaced inflation, but real returns are lower than nominal returns.

Not designed for income. Index funds are designed for growth, not cash flow. If you need $2,000/month from your investments, you’ll need roughly $600,000–$800,000 invested (using the 3–4% withdrawal rate). Building that takes decades.

Behaviour risk — the biggest one. The number one reason people fail with index funds is selling during downturns. Studies from Dalbar consistently show that the average investor significantly underperforms the index they’re invested in — not because the fund fails, but because the investor buys high, sells low, and jumps in and out at the worst times.

Pros and Cons

Pros: Lowest-cost way to invest in the stock market (fees often under 0.05%). Requires zero stock-picking knowledge or skill. Historically produces 8–12% average annual returns over long periods. Built-in diversification across hundreds or thousands of companies. Fully passive after initial setup — no daily monitoring needed. Available in any brokerage account, IRA, or 401k. Warren Buffett’s personal recommendation for most investors. Tax-efficient compared to actively managed funds.

Cons: Returns are market-rate by design — you can’t outperform the index. Short-term losses of 20–50% occur periodically and unpredictably. Meaningful wealth accumulation takes 15–30 years. Not suitable for generating near-term income. Requires emotional discipline to hold through market crashes. Doesn’t protect against market-wide downturns (only against individual company risk).

Who Index Funds Are For

Index fund investing is ideal if you’re saving for retirement 15–30+ years away, want the simplest possible investment approach, are comfortable with “market-rate” returns and don’t need to beat the market, can commit to regular monthly contributions over many years, have the temperament to hold through 20–40% downturns without selling, or want to build a seven-figure portfolio over time with minimal effort.

Who Index Funds Are NOT For

This approach doesn’t fit if you need income from your investments within the next few years, are starting with very little capital and need to generate income quickly, want to actively manage your investments and try to beat the market, cannot handle the emotional stress of watching your portfolio drop significantly during downturns, or are looking for “passive income” in the near term (index funds build wealth, not immediate income).

For those starting with limited capital, see why most people fail at making money online — the failure point is usually mismatched expectations about timeline and effort.

How to Start Investing in Index Funds

Step 1: Choose your account type. For retirement savings, a Roth IRA or traditional IRA offers tax advantages. If your employer offers a 401k with an index fund option, use it — especially if they match contributions (that’s free money). For non-retirement investing, a standard taxable brokerage account works.

Step 2: Pick a brokerage. Fidelity, Vanguard, and Charles Schwab are the three most popular for index fund investors. All offer their own low-cost index funds and commission-free trading. Choose based on interface preference — performance will be nearly identical.

Step 3: Select your fund(s). For most beginners, a single S&P 500 index fund or total stock market index fund is sufficient. As your portfolio grows, you might add an international index fund and a bond index fund for broader diversification.

Popular choices: Vanguard’s VOO (S&P 500 ETF, 0.03% expense ratio), Fidelity’s FXAIX (S&P 500 mutual fund, 0.015% expense ratio), or Schwab’s SWTSX (total stock market mutual fund, 0.03% expense ratio).

Step 4: Automate contributions. Set up recurring monthly transfers from your bank account to your brokerage, and schedule automatic purchases of your chosen fund. This removes decision-making from the process.

Step 5: Reinvest dividends. Turn on automatic dividend reinvestment. Every dividend payment buys more shares, which generate more dividends, which buy more shares. This is compounding in action.

Step 6: Rebalance annually. Once a year, check your allocation. If you hold multiple funds (U.S. stocks, international stocks, bonds), rebalance to your target percentages. This is the only active decision required.

For staying informed on market developments and fund analysis, see stock newsletters.

Index Funds vs. ETFs: Clearing Up the Confusion

Many beginners use “index fund” and “ETF” interchangeably. They’re related but not identical.

An index fund is a strategy — any fund that tracks an index. An ETF is a structure — a fund that trades on an exchange. You can have an index fund that’s structured as an ETF (like Vanguard’s VOO) or as a mutual fund (like Vanguard’s VFIAX). Both track the S&P 500, both have nearly identical returns.

The practical differences are minor: ETFs trade throughout the day, mutual funds trade once daily. ETFs have no minimum investment, some mutual fund versions require $1,000–$3,000. ETFs are slightly more tax-efficient in taxable accounts.

Either structure works perfectly well. For a deeper comparison, see how to make money with ETFs.

Frequently Asked Questions

Can you become a millionaire with index funds? Yes, and many people have. Investing $500/month at a 9% average annual return for 30 years produces approximately $918,000. Investing $750/month reaches $1.37 million. The timeline is long but the math is reliable.

What if the market crashes right after I invest? If you’re investing for 20+ years, a crash early in your investing period is actually beneficial — you’re buying more shares at cheaper prices. Your future self will thank the crash. The only scenario where crashes hurt long-term investors is if they sell during the downturn.

Should I invest a lump sum or use dollar-cost averaging? Statistically, lump-sum investing outperforms DCA roughly 65% of the time because markets rise more often than they fall. But DCA reduces the risk of investing everything at a peak and is psychologically easier for most people. If you’re unsure, DCA is the safer approach.

How much do I need to retire on index funds? A common guideline is the “4% rule” — you can withdraw 4% of your portfolio annually with a low risk of running out of money over a 30-year retirement. To withdraw $50,000/year, you’d need roughly $1.25 million. To withdraw $80,000/year, roughly $2 million.

Are index funds better than picking individual stocks? For most people, yes. Over 15-year periods, roughly 90% of professional fund managers fail to beat the S&P 500 index. The average individual investor performs even worse. Unless you have exceptional knowledge and discipline, index funds are statistically the smarter choice.

Do index funds pay dividends? Yes. S&P 500 index funds typically yield 1.3–2.0%. Total stock market index funds yield slightly less. Dividends are distributed quarterly and can be reinvested automatically.

The Bottom Line

Index fund investing is the closest thing to a guaranteed wealth-building strategy that exists in finance. Not guaranteed in any single year — but over 20–30 year periods, the historical track record is remarkably consistent. It requires no expertise, minimal fees, and about 30 minutes of setup time.

The only requirements are patience and consistency. Invest regularly, reinvest dividends, don’t sell during downturns, and wait. The compounding does the rest.

Where most people stumble isn’t the strategy — it’s the starting capital. If you’re investing $100/month, you’re doing the right thing, but it will take decades to reach meaningful figures. That’s why I always recommend building an income source first — something that generates cash flow you can then pour into index funds to compound over time.

That combination — near-term business income funding long-term market investments — is the most powerful wealth-building framework I’ve found. If you want to see the income side of that equation, here’s the model I use to build simple websites that generate $500–$1,200/month each in recurring revenue.