Should You Buy the SPDR S&P 500?

There's rarely a bad time to buy the world's biggest exchange-traded fund, the SPDR S&P 500.

Aug 14, 2014 at 6:30PM

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No matter how much I rack my brain, I can't think of a better investment than an index fund that tracks the S&P 500. And the biggest and best-known of the bunch is the SPDR S&P 500, an exchange-traded fund run by Boston-based State Street.

I could go on and on about why this is the case and why it's therefore a good time to buy the popular index now, but I'll limit myself to two reasons.

The SPDR S&P 500 is cheap and easy

Very few investors have an unlimited amount of time to research investment alternatives. On top of this, even fewer have the expertise needed to identify a great stock.

Sure, a guy like Warren Buffett makes investing in common stocks look easy. But the reality is that it's extremely hard to do so profitably. By his own admission, Buffett reads upwards of 500 pages of annual reports a day to gain the necessary insight to do so.

Suffice it to say that most of us have neither the time nor the discipline to follow this approach. And this is why the SPDR S&P 500 can serve as such a valuable proxy.

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As Buffett himself noted in Berkshire Hathaway's latest annual letter to shareholders:

My advice to the trustee [of my wife's portion of my estate] could not be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. (I suggest Vanguard's.) I believe the trust's long-term results from this policy will be superior to those attained by most investors -- whether pension funds, institutions or individuals -- who employ high-fee managers.

Why would Buffett do this? Because the S&P 500 tracks the biggest and best publicly traded companies in America -- click here to learn more about how the index works. According to Standard & Poor's, "The index includes 500 leading companies and captures approximately 80% coverage of available market capitalization."

On top of this, unlike a mutual fund, an ETF charges very low management fees. The SPDR S&P 500 sports an expense ratio of only 0.09%, meaning that it charges you less than a tenth of a percent of your investment each year. An actively managed mutual fund, by contrast, will cost you somewhere in the neighborhood of 1.5%.

The SPDR S&P 500 will probably maximize your returns

The second reason to invest in the SPDR S&P 500 is that doing so will almost certainly produce better returns than leaving your money in cash or buying and selling individual stocks.

The research on this point is unequivocal: The vast majority of investors underperform the market. Industry research suggests that the broader market beats the average investor by a factor of two -- that is, for every 1% return generated by a typical investor, the broader market gains 2%.

Indeed, even the lion's share of hedge funds can't match the S&P 500. Take the chart below, which compares the most widely followed hedge fund index to the performance of the large-cap index since 2005. As you can see, the average hedge fund has returned roughly 30% over this stretch, while the S&P 500 is up by about 60%.

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The one downside to buying the SPDR S&P 500 right now is that stocks are admittedly expensive. At its current price, the fund is more than 25% higher than its pre-crisis peak.

Additionally, according to valuation data curated by Yale's Robert Shiller, there have only been a handful of occasions in the past when the S&P 500, as a whole, was more expensive than it currently is. During the last 130-plus years, the average 10-year cyclically adjusted price-to-earnings ratio of the index has been 16.55. Today, it's 25.4.

The bottom line on the SPDR S&P 500

There's a reason the SPDR S&P 500 is the nation's largest exchange-traded fund, as there are few downsides to using it as the core -- or even the only -- holding in your long-term investment portfolio.

Is right now the most ideal time to buy it?

That's open to debate, given the current heights of the stock market. At the same time, however, if you're investing for the long run, the timing of when you buy is much less important than the length of your holding period. And it's for this reason that I believe there's never a bad time to invest in the SPDR S&P 500.

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