The Ultimate Guide to the Vanguard S&P 500 ETF: Strategies to Buy, Hold, and Profit

The stock market is very good at building wealth in the long run. The growth may slow down for a few years after huge challenges such as world wars, oil crises, and the end of the dot-com bubble. But the bad times never last long, and Wall Street has always beat inflation over several decades -- even if you started investing just before a huge downturn. Past performance is no guarantee of future results, but this long-lasting trend probably isn't going away any time soon.

That's why a broadly diversified index fund like the Vanguard S&P 500 ETF (NYSEMKT: VOO) should be at the top of every investor's first shopping list. The fund can also be the foundation of a thoughtfully designed portfolio, or play several useful supporting roles in other investment styles.

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So let's take a closer look at the Vanguard S&P 500 ETF. Here's how this single-ticker investor toolbox can help you build generational wealth.

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Why the Vanguard S&P 500 ETF?

The stock market comes with a bewildering number of choices, including several thousand individual stocks and a similar number of exchange-traded funds (ETFs). Choosing a broadly diversified ETF is a good start for any investor, especially if it comes with hard-to-beat performance and low annual fees.

The Vanguard S&P 500 ETF fits the bill. It holds shares of about 500 American companies, reflecting the components of the S&P 500 (SNPINDEX: ^GSPC) market index. That index is a selection of strong and financially stable businesses, hand-picked by an expert panel. The Vanguard fund is highly automated, leaving the heavy research lifting to that S&P Global (NYSE: SPGI) panel, which keeps investors fees at a forgettably low 0.03% per year.

As for long-term performance, about 55 ETFs have beaten this Vanguard fund's average returns over the past 10 years without resorting to financial tricks such as leveraged funds. That's not too shabby, compared to a peer group of more than 920 ETFs with at least 10 years of market history.

4 ways to make the most of your Vanguard S&P 500 ETF investment

This Swiss army knife of investing tools can do a lot for you. Here are four important strategies that work hand in hand to boost your results over a long period -- the longer, the better!

DRIP investing

Most of the S&P 500 stocks tend to pay dividends. Eighty-three percent of the 503 component stocks have an active dividend policy today, and those payouts are passed on to holders of the Vanguard S&P 500 ETF. The effective yield stands at 1.2% nowadays, just below the five-year average of 1.5% and the 10-year mean at 1.7%.

That may not sound like much, but the dividend payouts make a significant difference over the years. If you invested $10,000 in this fund 10 years ago, those shares would be worth $27,240 by now. If you reinvested the dividends in more ETF shares along the way, you'd have $32,560 instead:

VOO Total Return Price data by YCharts

So-called dividend reinvestment plans (DRIP) make it easy to take full advantage of those game-changing payouts. Most online stock brokerages let you simply click a checkbox to enable this policy, and then you can let it ride forever. As you can see in the chart above, enabling DRIP for the Vanguard S&P 500 ETF adds nearly 20% to your returns in a single decade. And the advantage only grows larger over time -- the dividend-boosted total return of the S&P 500 was 46% greater than the plain price gains over the last 20 years.

Automated investing and dollar-cost averaging

Automating your investments will help you stay committed to your strategy through thick and thin. Any brokerage worth using provides tools to automate money transfers and stock purchases. Set them up on a monthly or even weekly basis, forget about your modest contributions for years, and be amazed at the long-term results.

Let's say you start with a measly $100 investment in this ETF, but commit to adding another $100 per month for the foreseeable future. I'll assume a compound annual growth rate of 10% on your ETF's total returns, which include reinvested dividend payouts -- right in line with the index's long-term averages.

One decade later, you will have sent $12,000 to your stock brokerage. But the portfolio as a whole will be worth roughly $20,750, including 8,650 of investment returns. If you keep your contributions coming for 30 years, you'll see $36,000 of slow and steady cash investments blossom into a single-ETF portfolio worth approximately $228,000.

It's amazing what $100 a month can do in the long run, and this example isn't even "beating the market." Simply matching the gains of the S&P 500 is more than enough to deliver game-changing results in due time.

Tax-efficient moves

Uncle Sam will want a share of your gains at some point. If you just open a standard brokerage account, you'll put after-tax dollars into that account and then pay capital gains tax when you sell your investments and withdraw the resulting cash. Smart tax-mitigation strategies can lighten the Federal load, but you should also consider going a more tax-efficient route from the start.

There are several options on the table. A traditional Individual Retirement Account (IRA) lets you send pre-tax dollars into the account but applies capital gains taxes to withdrawals. That's a tax deduction on the input end, but a potentially heavy tax load after retirement. Roth IRA accounts work the other way around, putting after-tax dollars to work but skipping the tax calculations at the end. Here, you don't get up-front tax deduction but you will enjoy tax-free withdrawals in your golden years.

There are also 401(k) plans in both the traditional and Roth styles. These plans come with other benefits such as letting your employer match your paycheck-deduction 401(k) contributions.

You can also combine two or more of these account types to fit your financial needs and retirement planning. All of them can be automated, and the Vanguard S&P 500 ETF is a popular investment option across these plan types. Some 401(k) plans might not support Vanguard funds, but there will almost always be some sort of S&P 500 index fund available.

You probably won't dodge Uncle Sam's long arm entirely, but many tools will help you limit the long-term tax effects on your automated ETF gains.

Patience and bravery through volatile markets

The fully automated strategy I described earlier is an example of dollar-cost averaging. This effective investment strategy helps you stay on target when the stock market looks challenging. A constant money flow into the Vanguard S&P 500 ETF will buy more shares when the market is down and continue your basic commitment when the S&P 500 is soaring.

It's not so easy to send the next monthly check when you have to think about it. You might be tempted to send in more money when Wall Street is up, perhaps skipping the next check when the market is down. That's the exact opposite of the most effective strategy. "Be greedy when others are fearful," as master investor Warren Buffett says.

Dollar-cost averaging and similar automated plans may not result in optimal returns, but will at least be an emotionless middle ground between the high and low extremes. And you're always free to add a little more when the time is right -- meaning, when stock prices are down.

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Anders Bylund has positions in Vanguard S&P 500 ETF. The Motley Fool has positions in and recommends S&P Global and Vanguard S&P 500 ETF. The Motley Fool has a disclosure policy.