Want an investment strategy that the Oracle of Omaha would approve of? You don't need to spend hours scouring financial statements.
Warren Buffett has a pretty simple strategy that he thinks is the best way for the overwhelming majority of people to invest. Here's how the legendary chairman of Berkshire Hathaway (BRK.A -0.28%) (BRK.B -0.68%) thinks you should invest, even if you don't follow the stock market.
Image source: The Motley Fool.
1. Buy S&P 500 index funds
While Buffett is without a doubt the world's most famous stock picker, he doesn't think most people should invest in individual stocks. For years, he's embraced S&P 500 index funds as the best way for most Americans to build wealth. By investing in an S&P 500 fund, you become an automatic investor in all 500 companies whose stock the index tracks, including Berkshire Hathaway and many of its top holdings like Bank of America, Coca-Cola, Apple, and American Express.
Buffett has left instructions in his will stating that 90% of his personal wealth should be invested in S&P 500 index funds. The remaining 10% will be placed in short-term U.S. Treasuries.
Although Buffett is a longtime proponent of index investing for most people, Berkshire Hathaway only recently added two S&P 500 funds to its portfolio. In February, its 13F filing revealed that it had purchased shares of the Vanguard S&P 500 ETF and SPDR S&P 500 ETF, though combined the funds still make up less than 1% of Berkshire Hathaway's holdings.
2. Keep the fees low
Most fund managers who try to outperform a broad index like the S&P 500 will underperform in the long run, as Buffett frequently points out. That's why he loves to slam fund managers who charge high investment fees in spite of a not-so-stellar track record.
Buffett famously wagered $1 million that an S&P 500 index fund could beat five hedge funds over 10 years. He won the bet and donated the winnings to charity. One year earlier, he predicted his win in his 2016 letter to Berkshire Hathaway shareholders -- and fund manager fees were a major factor. "When trillions of dollars are managed by Wall Streeters charging high fees, it will usually be the managers who reap outsized profits, not the clients," Buffett wrote.
So when you invest in S&P 500 index funds, look for one with the lowest expense ratio possible. The lower the expense ratio, the more of your money actually goes into the investment. For example, if you invested $1,000 in a fund with a 0.1% expense ratio, $999 of your money would be invested and the remaining $1 goes toward fees. In case you were wondering, the Vanguard and SPDR funds Berkshire Hathaway owns have expense ratios of 0.03% and 0.09%, respectively.
3. Pay off credit cards before you invest
At Berkshire Hathaway's 2020 shareholder meeting, held virtually in May, Buffett was asked about the state of the credit card industry. He used the occasion to remind the world of the high cost of carrying a credit card balance -- even though Berkshire Hathaway often profits from credit cards, given its heavy financial sector holdings.
Buffett told the story of a friend who sought his advice about what to do with her money. He asked her if she had credit card debt. She did, with an APR of 18%.
Buffett told her that the interest savings from paying off the credit card debt would be far greater than she could earn from any investment. "I don't know how to make 18%," he said.
4. Practice dollar-cost averaging
Buffett isn't a fan of market timing. In February, at the start of the coronavirus pandemic, he told CNBC, "you can't predict the market by reading the daily newspaper."
Like his mentor Benjamin Graham, Buffett is a proponent of dollar-cost averaging, in which you invest regularly at fixed intervals no matter what's happening in the stock market. So when he recommends funds that track a broad-based index like the S&P 500, for most investors it's with a caveat: "Don't put your money in all at once; do it over a period of time."
5. Invest with a long time horizon
Some of Buffett's greatest words of wisdom are about the importance of long-term investing. Regardless of whether you follow his advice and stick with passively managed index funds or pick your own stocks, he suggests you ignore short-term results and focus on four- and five-year averages.
As long as you're invested across the stock market, Buffett believes you can count on good results over time. As he put it in his 2016 letter to Berkshire Hathaway shareholders, "American business -- and consequently a basket of stocks -- is virtually certain to be worth far more in the years ahead."
