Berkshire Hathaway (NYSE:BRK.A)(NYSE:BRK.B) CEO Warren Buffett has famously said that the best investment option for most Americans is simple, low-cost index funds. Buffett has mentioned S&P 500 index funds in particular, saying that such an investment is a bet on American business, which should perform quite well over time.
This advice seemed puzzling to many investors. After all, Buffett is one of the most highly regarded stock pickers of all time, with Berkshire Hathaway's stock portfolio handily outperforming the S&P 500 index over the years. What's more, although Buffett has been an outspoken supporter of low-cost index funds, he hasn't bought any for Berkshire's portfolio -- until now.
Berkshire's index fund investment
In Berkshire Hathaway's most recent 13F filing, there were a couple of index fund purchases that were publicly revealed for the first time.
Specifically, Berkshire bought shares of the Vanguard S&P 500 ETF (NYSEMKT:VOO) and SPDR S&P 500 ETF (NYSEMKT:SPY). Both purchases took place in the fourth quarter and were rather small by Berkshire's standards. They account for a combined $25 million of Berkshire Hathaway's portfolio, while the company's larger stock positions are in the tens of billions of dollars.
However, I wouldn't be surprised if these were just the beginning, and Berkshire ends up building significant index fund holdings in the quarters and years to come.
Why does Buffett like S&P 500 index funds so much?
To be perfectly clear, Warren Buffett still believes that it's possible to beat the market by researching and selecting individual stocks to invest in. Berkshire spent far more on individual stocks during the fourth quarter than it did on its two relatively minuscule S&P 500 index fund positions.
Having said that, Buffett likes passive index funds like those Berkshire purchased for a couple reasons. For one, it takes the guesswork out of stock investing -- Berkshire's S&P 500 index funds should achieve identical performance to the S&P 500 over time, no more and no less. This means that investors don't have to worry about the valuation or performance of any single company or industry. And with long-term returns that average nearly 10% per year, the S&P 500 can produce pretty impressive returns all by itself.
Second, index funds like these allow investors to gain exposure to a diverse group of stocks at a fraction of the expense of buying an actively managed mutual fund. The typical mutual fund has an expense ratio -- fees as a percentage of invested assets -- in the 0.50% to 1% range. Meanwhile, the Vanguard and SPDR funds Berkshire just bought have expense ratios of 0.04% and 0.03%, respectively.
What does it mean?
In recent years, Berkshire Hathaway has developed quite a cash problem. The company's operating businesses continue to generate billions of dollars every quarter, while Buffett and the rest of Berkshire's management team have had a difficult time finding attractive investment opportunities -- both in the stock market and when it comes to acquisition targets.
Nobody knows exactly what Buffett is thinking, and we don't even know if it was Buffett himself who authorized the index fund investment. However, it could be that since Berkshire has tons of cash on the sidelines and few buying opportunities, Buffett simply decided to take his own advice and bet on American business.