Here's the Smartest Way to Invest in the S&P 500 in January

Last year was a fantastic one for stocks and stock market investors. The S&P 500 (SNPINDEX: ^GSPC)
roared into the new year, confirming a bull market, and finished 2024 with a double-digit gain. This is after already advancing 24% in the previous year.

Though stocks across industries climbed, investors favored companies playing a role in the newish and hot growth area of artificial intelligence (AI). As a result, AI stocks Nvidia and Palantir Technologies posted the biggest gains in the Dow Jones Industrial Average (DJINDICES: ^DJI) and the S&P 500, respectively, in 2024.

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Today, at the start of another new year, there's reason to be optimistic about what's next for the stock market as the positive momentum continues. The AI growth story is in its early days, and the general economic environment is brightening -- recent interest rate cuts should benefit companies and households in the months to come.

All of this means now is a great time to invest in the S&P 500. But what's the smartest way to do that? Let's find out.

Image source: Getty Images.

How the S&P 500 works

First, let's talk a bit about the S&P 500. This benchmark has been around in its current form, including 500 companies, since the late 1950s. It admits and removes members periodically to ensure that it always includes the companies driving the economy of the times. A company also must have a minimum market value of $18 billion to be included, since the benchmark measures only the performance of large-cap stocks.

An invitation to join the index represents a huge milestone for a company, showing it's entered an elite group of its American peers. When you invest in the S&P 500, you're investing in the country's top companies -- and this means it's no surprise the S&P 500 has been a winning investment over time. Since its launch, the index has delivered an annualized average return of 10%.

Now let's consider the smartest way to invest in this benchmark that has proven to be red-hot over the past two years. And this is by investing in a fund that tracks it. My favorites are the Vanguard S&P 500 ETF (NYSEMKT: VOO) and the SPDR S&P 500 ETF Trust (NYSEMKT: SPY), two exchange-traded funds (ETFs) that mimic the index's composition -- and therefore deliver the same returns. These ETFs are very similar, so either one makes a great addition to your portfolio.

Diversification across industries

The Vanguard and SPDR funds, like the S&P 500 itself, are heavily weighted in technology today, but they include 10 other industries -- this is a fantastic combination because it offers you exposure to the day's hot stocks, as well as diversification across stocks and sectors. And buying shares of these funds is just as easy as buying a stock because they trade daily on the market just like stocks.

The only major difference is these funds come with a management fee, expressed as an expense ratio. You'll always want to choose ETFs with expense ratios of less than 1%, and these two largely fit our criteria. The Vanguard's ratio is 0.03%, while the SPDR's is 0.09%. These low expense ratios ensure that costs won't eat into your returns over time.

A couple of smart ways to invest

You can invest in these funds in a couple of different ways. You could make one big purchase and hold on for the long term. If history is any guide, you're likely to score a win by using this strategy. As mentioned, over time, the index has posted a double-digit annualized gain.

Or you can take advantage of the magic of compounding and make an initial investment today and continue investing a certain amount of money in the ETF monthly over a very long period. This strategy can significantly grow your investment. For example, considering a 10% annualized average gain over time, as the index has delivered in the past, if you invest $1,000 today and commit $100 a month over 35 years, you would contribute $43,000 -- and your returns would surpass $310,300.

Your decision to invest either all at once or over time will depend on your investment horizon and general strategy. But considering the track record of the S&P 500 over time and in recent months, either makes a smart way to invest in this booming index right now in January.

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Adria Cimino has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Nvidia, Palantir Technologies, and Vanguard S&P 500 ETF. The Motley Fool has a disclosure policy.