The Spy ETF Is the Kind of Investment Warren Buffett Thinks You Should Own

This article was originally published on October 18, 2015. It was updated on August 22, 2017.

Open your newspaper to the stock listings or scan through a long list of the best mutual funds and it's easy to find yourself confused and frustrated. Unless you know a lot about the stock market and investing, the thousands of stocks and funds out there can make it hard to know which ones to choose. Fortunately, there's a simple solution for most of us, and it reflects an investing strategy that even superinvestor Warren Buffett has endorsed: the SPY ETF.

I'm referring to the SPDR S&P 500 ETF (SPY -0.21%), which has the intriguing ticker symbol SPY and is sometimes referred to by its nickname, "Spider." ETFs are exchange-traded funds, investments that trade like stocks but are structured more like mutual funds, containing a variety of holdings. In the case of the SPY ETF, its holdings are the 500 companies that make up the S&P 500, and that together make up about 80% of the overall U.S. stock market's value. Thus, the SPY ETF essentially tracks the performance of the overall U.S. stock market.

The SPY ETF gets its name from the SPDR in its full name. Its nickname is Spider. Image source: Getty Images.

Buffett on indexing

A key benefit of broad-market index funds is diversification. You're not putting your hard-earned eggs in one or just a few baskets but in hundreds of baskets. If one or a handful of companies implode, they won't take your retirement savings with them.

As Buffett explained in his 1993 letter to shareholders:

Another situation requiring wide diversification occurs when an investor who does not understand the economics of specific businesses nevertheless believes it in his interest to be a long- term owner of American industry. That investor should both own a large number of equities and space out his purchases. By periodically investing in an index fund, for example, the know-nothing investor can actually out-perform most investment professionals. Paradoxically, when "dumb" money acknowledges its limitations, it ceases to be dumb.

It's worth noting here that Buffett is also advocating investing regularly, such as by dollar-cost averaging, where you plunk a set amount into an investment on a fixed schedule, whether the market is up or down. It's what you're doing if you're participating in a 401(k) at work, having money regularly transferred from your paycheck to investments you selected in your 401(k).

Buffett is doing more than just talking about indexing, too. In his 2013 letter to shareholders, he explained that:

My money, I should add, is where my mouth is: What I advise here is essentially identical to certain instructions I've laid out in my will. One bequest provides that cash will be delivered to a trustee for my wife's benefit. ... My advice to the trustee 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.

The Vanguard S&P 500 Index Fund is a fine fund, with very low fees. But many times mutual funds have minimum initial investment amounts that can present a bit of a hurdle. The Vanguard fund has a minimum of $3,000, for example. One advantage of ETFs is that there are no minimums. Since they trade like stocks, you don't need to open an account with a mutual fund company or look for the fund you want among your 401(k) options or among your brokerage's offerings. You can just place an order through your brokerage and can buy as little as a single share -- though if you're paying, say, a $10 commission for a $200 share, you're paying 5% of your investment in trading commissions, which is a bit steep. (The SPY ETF recently traded near $247 per share.) The SPY ETF also sports a very low annual fee of 0.09%. Both it and the Vanguard fund sport dividend yields that were recently near 2%.

Image source: Getty Images.

Performance

You can expect to earn roughly the same return as the S&P 500 with the SPY ETF -- and over long periods, that has been enough to outperform most managed mutual funds. Check out this data from the folks at S&P Dow Jones Indices:

Annualized returns, as of the end of 2016.

Indeed, over the past 10 years, 85% of large-cap mutual funds were outperformed by the S&P 500.

Image source: Getty Images.

Strategies

If you want to invest in an inexpensive S&P 500-based index fund, the SPY ETF is a smart option. For those who don't have the time, energy, or interest to choose and manage individual securities, parking most or all of your long-term dollars in it is a very reasonable move. If you do want to choose individual securities, you might let an index fund serve as ballast, keeping a significant chunk of your assets in it.

You might consider other solid index funds, too, such as ones covering different broad markets. Examples include the Vanguard Total Stock Market ETF and the Vanguard Total World Stock ETF. Respectively, they distribute your assets across the entire U.S. market and just about all of the world's stock markets. You can gain exposure to the bond market via index ETFs such as the Vanguard Total Bond Market ETF and the iShares Core Total U.S. Bond Market ETF.

Investing doesn't have to be terribly complicated. You can do very well by just leaving money for decades in inexpensive broad-market index funds.