Want an investment strategy that the Oracle of Omaha would approve of? You don’t need to spend countless hours scouring financial statements and reading stock reports. Warren Buffett has a pretty simple strategy that he thinks is the best way for the overwhelming majority of people to invest.
1. Buy S&P500 Index Funds
While Buffett is without a doubt the world’s most famous stock picker, he doesn’t think most people should invest in individual stocks. For years, he’s embraced S&P500 index funds as the best way for most Americans to build wealth. By investing in an S&P500 fund you become an automatic investor in all 500 largest companies whose stock the index tracks, including Berkshire Hathaway, Amazon, Apple, Facebook, Google and so on.
Buffett has left instructions in his will stating that 90% of his personal wealth should be invested in the S&P500 index funds. The remaining 10% will be placed in short-term US treasuries.
Although Buffett is a long-time proponent of index investing for most people, Berkshire Hathaway only recently added two S&P500 funds to its portfolio in February 2020. Its 13F filing revealed that it had purchased shares of the Vanguard S&P500 ETF and SPDR ETF, though combined the funds still make up less than 1% of Berkshire Hathaway’s holdings. Let’s take a moment and see what Warren Buffett himself has to say about investing in index funds:
“So I would pick a broad index, but I wouldn’t toss a chunk in at any one time. I would do it over a period of time, because the very nature of index funds is that you are saying, ‘I think America’s business is going to do reasonably well over a long period of time, but I don’t know enough to pick the winners and I don’t know enough to pick the winning times.’ There’s nothing wrong with that. I don’t know enough to pick the winning times; occasionally I think I know enough to pick a winner but not very often and I certainly can’t pick winners by going down through the whole list and saying, ‘this is a winner and this isn’t,’ and so on. So the important thing to do, if you have an overall feeling that businesses is a reasonable place to have your money over a long period of time is to invest over a long period of time and not make any bet implicitly by putting a big chunk in at a given time. As to the criteria as to when you should or shouldn’t, I don’t think there are any great criteria on that. I don’t think price-to-earnings ratio determines things. I don’t think price-to-book ratios, price-to-sales ratios, I don’t think there’s a single metric I can give you or that anyone else can give you in my view that will tell you this is a great time to buy stocks or not to buy stocks or anything of this sort. It just isn’t that easy.
That’s why you go to an index fund, and that’s why you buy over a period of time. It isn’t that easy. You can’t get it by reading a magazine; you can’t get it by watching television; you can’t; you’d love to have something that said you know if PE is 12 or below or some number you’re buying; if they’re 25 or above you’re selling. It doesn’t work that way. It’s a more complex business than that. It couldn’t be that easy, when you think about it.
So if you are buying an index fund, you are protecting yourself against the fact that you don’t know the answers to those questions. But you do think you can do well over time without knowing the answers to those questions as long as you consciously recognize that fact.
If you’re a young person, and you intend to save a portion of your income over time, I just say just pick out a very broad index and I would probably use the S&P500, because I think if you start getting beyond that you start starting to think you should be in small caps this time and large caps that time, or this foreign side; and as soon as you do that you know you’re in a game you are not equipped to play in.
In all candor, that would be my recommendation”
100 years ago one share of S&P500 was trading at less than $10. Now, one share costs nearly $3,500. So if you would have invested 100 years ago and withstood all the fluctuations and volatility, you would have generated 350x times your money today. Not bad at all. Not doing any financial research and still becoming wealthy.
On average S&P500 generates 10% annual compound interest rate.
As Albert Einstein once said, compound interest is the eighth wonder of the world. He who understands it earns it; he who doesn’t, pays it.”
2. Keep the Fees Low
Most fund managers who try to outperform a broad index like the S&P500 will underperform in the long run, as Buffett frequently points out. That’s why he loves to slam fund managers who charge high investment fees. In spite of a not so stellar track record, Buffett famously bet 1 million dollars that an S&P500 index could beat 5 hedge funds over 10 years.
Of course he won the bet and donated the winnings to charity. One year earlier he predicted his win in a 2016 letter to Berkshire Hathaway shareholders and fund manager fees were a major factor. Quote: “when trillions of dollars are managed by wall streeters charging high fees, it’ll usually be the managers who reap outsized profits, not the clients” Buffett wrote. So when you invest in S&P500 index funds look for the one with the lowest expense ratio possible; the lower the expense ratio, the more of your money actually goes into the investment. For example, if you invested $1,000 in a fund with a 0.1% expense ratio, $999 of your money would be invested and the remaining $1 goes toward fees.
In case you were wondering, the Vanguard and SPDR ETF that Berkshire Hathaway owns have an expense ratios of 0.03% and 0.09% respectively.
3. Pay Off Credit Cards Before You Invest
At Berkshire Hathaway’s 2020 shareholder meeting held virtually in May, Buffett was asked about the state of the credit card industry. He used the occasion to remind the world of the high cost of carrying a credit card balance, even though Berkshire Hathaway often profits from credit cards given its heavy financial sector holdings.
Buffett told the story of a friend who sought his advice about what to do with her money. He asked her if she had credit card debt; she did, with an APR of 18%. Buffett told her that the interest savings from paying off the credit card debt would be far greater than she could earn from any investment. “I don’t know how to make 18%,” he said.
Photo by Mikhail Nilov on Pexels.com
4. Practice Dollar-Cost-Averaging
Buffett isn’t a fan of market timing. In February 2020, at the start of the coronavirus pandemic, he told CNBC, ” you can’t predict the market by reading the daily newspaper.” Like his mentor, Benjamin Graham, Buffett is a proponent of dollar-cost-averaging, in which you invest regularly at fixed intervals no matter what’s happening in the stock market.
So when he recommends funds that track a broad-based index – like the S&P500 – for most investors, it’s with a caveat: don’t put your money in all at once; do it over a period of time.
5. Invest With a Long-Term Horizon
Some of Buffett’s greatest words of wisdom are about the importance of long-term investing. Regardless of whether you follow his advice and stick with passively managed index funds or pick your own stocks, he suggests you ignore short-term results. No one can predict what might happen in the stock market in the short term most of the time. Financial news is all just random noise. Focus on long-term investing. Have a time horizon, in decades not in days or weeks.
Buffett believes you can count on good results over time. As he put it in his 2016 letter to Berkshire Hathaway shareholders, “American business and consequently a basket of stocks is virtually certain to be worth far more in the years ahead.”
Let me know what you think about investing in index funds. Leave your thoughts in the comment section below. Share this article with a friend that is new to investment and SUBSCRIBE! to get the following posts.
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