What would Warren Buffett tell you to do with your money? He'd probably recommend investing in a low-cost S&P 500 index fund. In fact, that's exactly how his will instructs that most of the money his family inherits be invested.
Some individual investors might be worried about stock-market volatility after the beatdown experienced last year. But a study of history reveals something quite interesting. Here's a surprisingly reliable way for investors to make money.
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Easy money
You're going to love the simplicity of this investing approach. It only has three steps:
- At the beginning of the year, look at the S&P 500's return for the previous year.
- If the previous year's return was negative, invest in an S&P 500 index fund.
- Sell the S&P 500 index fund at the end of the year.
Just how reliable is this strategy? It's made money 82.6% of the time over the last 83 years. If you found a casino in Las Vegas that offered those kinds of odds, it would soon go out of business because so many gamblers would be pocketing a ton of cash.
We're not talking about puny profits, either. Following this approach has delivered an average annual return of 12.8% historically.
Granted, actual returns would have been a little lower because of expenses. However, there are several S&P 500 exchange-traded funds with low expense ratios. For example, the Vanguard S&P 500 ETF (VOO -0.84%) only charges 0.03% per year. Buying this index fund ETF would allow you to keep most of the nice gains associated with this approach for yourself.
The catch
There's usually a catch with something that seems to be so great. Unfortunately, that's the case with this investing strategy.
What is this catch? The S&P 500 simply doesn't have enough bad years. Since 1940, the index has ended the year with a loss only 24 times. Really awful years are even more infrequent. Including last year, the S&P 500 has fallen by 19.4% or more only seven times in its entire history.
The downside to these infrequent down years for the S&P 500 is that your cash would be parked on the sidelines a lot. As a result, the annualized returns over time wouldn't be nearly as great as that 12.8% figure mentioned earlier.
Sure, you could juice the returns somewhat by moving your money into U.S. Treasury bills when you weren't invested in an S&P 500 index fund. These T-bills are considered to be safe since they're backed by the U.S. government. However, your annualized return would still be a lot lower than the double-digit return we'd prefer.
Another even more reliable approach
I've got some great news for you, though: There's another even more reliable approach to making money investing in S&P 500 index funds. And it's even simpler than the strategy we just covered. This approach only has two steps:
- Buy an S&P 500 index fund.
- Hold it for at least five years.
This strategy has been profitable 87.9% of the time. If you want to increase that percentage, just hold the S&P 500 index fund longer. For example, buying and holding the S&P 500 for 10-year periods has delivered positive returns 94.2% of the time, historically.
Want to know the best approach of all? If you bought and held an S&P 500 fund for 20 years, you would have always made money. That's right -- this strategy has been a profitable one 100% of the time going all the way back to 1872.
Now you know why Warren Buffett wants his family to invest in S&P 500 index funds after he's gone. He knows that it's been a reliable way to make money in the past. And it probably will be in the future, too.
