Economic growth slowed last year as high inflation and climbing interest rates weighed on consumer spending. Those headwinds cut into corporate profits and stoked recession fears that brought about a sweeping decline in the stock market.
The S&P 500 had its worst year since the Great Recession. The broad-based index dropped into bear market territory on the first trading day of 2022, and it is still 19% off its high.
That drawdown has put a dent in many portfolios, but investors need to keep a level head. Past bear markets have always ended in bull markets that propelled the S&P 500 to new highs, and there is no reason to expect a different outcome this time. That's why investors should treat the drawdown as a buying opportunity.
Here's advice from Warren Buffett.
Warren Buffett has frequently recommended an S&P 500 index fund
It is no accident that Buffett is regarded as one of the most successful investors in history. Under his leadership, Berkshire Hathaway has become one of the largest companies in the world, and its $300 billion investment portfolio is packed with stocks that have grown in value multiple times, including Coca-Cola, American Express, and Chnese EV maker BYD. Meanwhile, Buffett himself has amassed a $100 billion fortune.
Those bona fides make his investing advice especially credible, and Buffett has often said an S&P 500 index fund is the best way for most investors to gain exposure to the stock market.
In fact, he believes the average investor can actually outperform most professional money managers by regularly buying an S&P 500 index fund. The key word is regularly. Investors should add to their position through thick and thin to avoid the pitfalls of market timing.
Buffett once bet a half-million dollars on the S&P 500
Buffett once wagered $500,000 that no professional investor could outperform an unmanaged S&P 500 index fund over a 10-year period. Protége Partners accepted the challenge, and the firm selected five hedge funds managed by five finance experts, who employed several hundred other finance experts. Suffice it to say Protége tried very hard to beat Buffett.
The bet began in December 2007, shortly before the S&P 500 collapsed during the Great Recession. The index ultimately lost 56% of its value, marking its sharpest decline since the Great Depression.
But Buffett still won the bet. The S&P 500 eventually recouped its losses, and produced a return of 126% by the end the 10-year period. Meanwhile, the best and worst Protége hedge funds produced returns of 88% and 3%, respectively.
Buffett made his point. He beat hundreds of highly trained finance experts without doing any work. He simply bought a Vanguard S&P 500 index fund and held it. It doesn't get much easier than that.
The Vanguard S&P 500 ETF
The Vanguard S&P 500 ETF (VOO 1.12%) tracks the performance of 500 large-cap U.S. companies. It includes value stocks and growth stocks from all 11 market sectors, and it has an expense ratio of just 0.03%. In other words, the Vanguard S&P 500 ETF allows investors to diversify across a variety of blue chip American businesses, and it costs next to nothing.
The top 10 holdings in the Vanguard ETF are detailed below:
- Apple: 6.3%
- Microsoft: 5.4%
- Alphabet: 3.3%
- Amazon: 2.7%
- Berkshire Hathaway: 1.6%
- Nvidia: 1.4%
- ExxonMobil: 1.4%
- UnitedHealth Group: 1.4%
- Tesla: 1.4%
- Johnson & Johnson: 1.3%
Admittedly, an S&P 500 index fund is somewhat boring compared to individual stocks, but investors mustn't conflate boring strategies with bad strategies.
The S&P 500 has consistently delivered solid returns over long periods. For instance, the index produced a total return of 600% over the last two decades, or 10.2% annually. At that pace, $150 invested each week would be worth $457,000 in two decades, and it would be worth $1.3 million in three decades.
To summarize, the investment thesis is straightforward: The Vanguard S&P 500 ETF is a cheap and easy way to spread capital across hundreds of excellent businesses, and investors can reasonably expect 10% annual returns over the long term. That's why 2023 is a great time to start buying this ETF.
