Warren Buffett is one of the greatest investors of all time, but those looking to follow the Oracle of Omaha's advice may be surprised to find he doesn't recommend that everyone pick individual stocks to invest in.
Instead, Buffett has indicated most investors would do better putting their money into an index fund rather than buying shares of individual companies. And he's actually gotten even more specific, recommending an S&P 500 fund. In a 2013 letter to Berkshire Hathaway shareholders, he even made clear he'd be putting this advice into action: He instructed that 90% of his wife's inheritance should be put into an S&P fund while the rest should be used to buy bonds.
If you're not interested in picking individual stocks and want to take a simpler approach to building wealth, you may be considering following this advice. But before you do, consider whether investing most of your money in the S&P 500 could leave your portfolio unbalanced.
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Should you invest 90% of your money into the S&P 500?
Most people who point out flaws with Buffett's 90/10 strategy focus on the fact that it will leave you overinvested in equities. And indeed, that could very well be the case. This would mean 90% of your portfolio is invested in stocks while common wisdom suggests subtracting your age from 110 to determine what percentage of your money should be in the market. If you're over the age of 20, therefore, Buffett's advice would mean you're taking on more risk than you should.
There's another potential problem, though. The S&P 500 is made up of 500 of the largest U.S. companies. That means if you're putting 90% of your money into an S&P fund (and buying bonds with the rest), you're betting your future on the ability of America's largest businesses to keep growing.
What you're not doing, however, is diversifying into other investments such as real estate, midsize or small companies, or emerging markets. And that can be a problem for a few reasons.
First, while investing in small and midsize companies presents greater risk, you also have the potential for greater rewards. By definition, bigger companies already control a larger share of the market, so their growth potential is more limited than enterprising start-ups that could become tomorrow's big players.
And by missing out on emerging-markets funds, you're not only giving up on investments with tremendous potential for growth, but you're also betting it all on the U.S. economy. This really leaves you with a lack of diversification, especially since your salary likely comes from a company in the U.S. and you probably have your savings in U.S. dollars, too.
How can you easily build a more diversified portfolio?
If you don't know how to invest in individual stocks or don't want to take the time to do it, you can still follow Buffett's advice and invest in index funds. But you should branch out beyond the S&P 500.
In fact, with just six ETFs, you can build a well-balanced portfolio in a matter of minutes. Here's an example of six funds you could buy that would give you exposure to large companies, small ones, midsize ones, bonds, real estate, and emerging markets:
- Schwab U.S. Large-Cap Growth (SCHG +0.74%)
- Schwab U.S. Mid-Cap (SCHM +0.76%)
- Schwab U.S. Small-Cap (SCHA +0.95%)
- Schwab Emerging Markets Equity (SCHE +2.06%)
- Vanguard Total Bond Market (BND +0.38%)
- iShares Dow Jones U.S. Real Estate (IYR +0.00%)
Of course, these are just six of many examples of funds with low fees that can provide a better balance that putting 90% of your money into the S&P 500. You can find others, too (The Motley Fool's model portfolios can help). If you take the time to find the right ones for you, you'll likely see better returns over time than if you followed Buffett's 90/10 plan.
