Warren Buffett’s Top Investment Pick: A Low-Cost Index Fund

Warren Buffett is one of the most popular, quotable investors in the world. The billionaire, now-retired former CEO of Berkshire Hathaway has a legendary investment track record, trouncing the return of the S&P 500 since 1965.

He made headlines — as he often does — in 2007, when he famously offered to bet $1 million that he could beat the returns of any hedge fund manager over a decade by simply buying and holding an S&P 500 index fund. Before 10 years had even elapsed, the only hedge fund manager to even accept the wager, Ted Seides, threw up his hands and conceded.

Buffett has also frequently been quoted as saying the S&P 500 index fund is the best option for most investors. So, why does Buffett believe so strongly in the S&P 500 index, and are there any caveats to his recommendation? Let’s take a closer look.

It’s Hard To Beat

At the end of the day, the best reason to choose investing in the S&P 500 is that very few managers have the ability to outperform it on a consistent basis. Even good stock pickers who might be able to beat the market find it hard to pass on those gains to individual investors, as fees and expenses can eat up a significant amount of return.

In almost every year since 2001, the majority of funds have underperformed the market, as seen in an infographic from Visual Capitalist. Over time, some reports indicate that roughly 90% of funds fail to keep pace with the S&P 500. When even professional money managers with huge research staffs and immense computing power can’t consistently tame the index, it’s a tough ask for the average investor to keep up.

It’s Low Cost

Buffett doesn’t slam fund managers for being ignorant or poor stock pickers. Rather, he condemns the fees that the fund industry charges. While some managers may very well be able to beat the market over various time periods, their returns are diminished by the fees they charge, particularly when it comes to private equity and hedge funds.

But a fund like the Vanguard S&P 500 Index (VOO) has an annual expense ratio of just 0.03%. That means that for every $1,000 you put into the fund, you’re paying just 30 cents in fees. Even on a $1 million portfolio, your annual expenses would only amount to $300. With nearly all of your money remaining invested rather than being siphoned off by fees, you by definition boost your returns.

It’s Diversified — Although Perhaps Not as Much as You Might Think

In one sense, you’ll be instantly diversified if you buy an S&P 500 index fund, as you’ll instantly own the largest 500 stocks in the United States. This gives you a lot of bang for your buck for a single investment.

It’s almost impossible for every single stock in the S&P 500 to be either up or down at the same time, so the ride can be smoother than owning an individual stock. Meanwhile, you’re diversified across every major industry in America.

However, there is one caveat to consider when owning the S&P 500. Although it does indeed offer exposure to hundreds of stocks, the index is market-cap-weighted. At the present time, the top ten stocks in the S&P 500 carry more than 34% of the value of the entire 500-stock index, and the top 20 comprise roughly 45%. This means that less than 5% of the whole index is responsible for nearly half of its performance.

It’s a Bet on America

One of Buffett’s oft-quoted reasons for buying the S&P 500 index is that he believes in America. In his shareholder letter with investors in 2022, Buffett said that in his entire investment career, he had “yet to see a time when it made sense to make a long-term bet against America.”

Back in 2018, he phrased it this way: “For 240 years it’s been a terrible mistake to bet against America. The babies being born in America today are the luckiest crop in history.” As the 500 biggest companies in America comprise the S&P 500 index, this is a great way to play Buffett’s optimism.

The S&P 500 Index Has Always Come Back

Unlike individual stocks, which can face bankruptcy or shed a great deal of their value and never recover, the S&P 500 has always come back from bear markets and corrections to set all-time highs. Even its volatility shouldn’t scare long-term investors, as the S&P 500 index, almost unbelievably, has never lost money over any 20-year period.

This supports Buffett’s belief in the long-term resilience of America, but for those with long time horizons, it should also ease fears about the volatility of the stock market costing them money.

This article was provided by MoneyLion.com for informational purposes only and should not be construed as financial, legal or tax advice.

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