Warren Buffett is a loser. Before you attempt to throw something at me through the Internet, allow me to clarify. The billionaire investor is losing compared to the overall market so far this year. The vast bulk of Buffett's fortune is in Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B). And Berkshire's shares are badly underperforming the S&P 500 index in 2020.
Of course, Buffett has trounced the overall stock market over his entire career. His track record in generating impressive returns had made him an investing legend and one of the wealthiest people in the world. Make no mistake about it: Buffett wants to be and usually is a winner.
But there are two of Warren Buffett's picks that will never beat the S&P 500. And Buffett knows it. Yet both remain in Berkshire Hathaway's portfolio. Here are those picks that might seem to be doomed to mediocrity -- and why you might want to buy them even anyway.
Tucked away in the basket of 40-plus stocks that Berkshire Hathaway owns are two exchange-traded funds (ETFs). One is the SPDR S&P 500 ETF Trust (NYSEMKT:SPY). The other is the Vanguard Index Fund S&P 500 ETF (NYSEMKT:VOO).
Neither the SPY nor the VOO will ever beat the S&P 500 index over an extended period of time. Never, ever. The reason why is simple.
You might have noticed that both of these ETFs have "S&P 500" in their names. That's because the funds track the S&P 500 index. Both the SPY and VOO are specifically built to mirror the returns that the S&P 500 index generates.
It is possible, though, that these ETFs could beat the overall stock market return. Although many Americans view the S&P 500 as the stock market, there are plenty of stocks that aren't included in the major index. Thousands of stocks have market caps too small to be considered for inclusion in the S&P 500 index. Stocks of other many other companies are excluded because they're not based in the U.S.
Why Buffett likes them (and you should too)
Warren Buffett has been a fan and advocate of investing in low-cost index funds for a long time. He has even instructed in his will that 90% of the money his family inherits when he dies is to be invested in a low-cost S&P 500 index fund. The remaining 10% is to be invested in short-term government bonds.
Why does Buffett like S&P 500 index funds so much? He once told another investing legend, Jack Bogle, that "a low-cost index fund is the most sensible equity investment for the great majority of investors. By periodically investing in an index fund, the know-nothing investor can actually out-perform most investment professionals."
Buffett put his money where his mouth is in 2007. He bet $1 million against hedge-fund manager Ted Seides that an S&P 500 index fund would beat a basket of five or more hedge funds over a 10-year period. Buffett easily won that bet in 2018, with a 7.1% annualized gain for the S&P 500 index fund compared to a 2.2% annualized gain for Seides' basket of hedge funds. He donated his winnings to a charity, Girls Inc. of Omaha.
Investing in the SPY and VOO ETFs could be a smart bet for many investors over the long run. You won't beat the S&P 500, but you won't underperform it either.
A key caveat
It's important to note that Warren Buffett doesn't follow his own advice for the most part. Even though Berkshire Hathaway owns two S&P 500 index ETFs, its positions in SPY and VOO amount to only a sliver of the total portfolio.
Picking individual stocks with tremendous growth potential is still a winning strategy to beat the S&P 500 and the overall stock market over the long run. Several of Berkshire's holdings have done just that, notably including Apple and Mastercard.
Of course, you have to pick the right stocks. For investors who don't think they can do so, buying low-cost index ETFs is a good call. Sometimes the secret to winning is simply not losing.