Warren Buffett has often said an S&P 500 index fund is the most sensible way for most investors to gain exposure to the stock market. The Vanguard S&P 500 ETF (VOO +1.21%) is one of several great options. In fact, Buffett owns shares of that particular S&P 500 index fund through Berkshire Hathaway.
Investors may be tempted to brush this advice aside. After all, buying an S&P 500 index fund is much less exciting than buying individual stocks. However, the index fund strategy can turn patient investors into stock market millionaires. Here's how.
The S&P 500 is a benchmark for the U.S. economy
The Vanguard S&P 500 ETF measures the performance of the S&P 500 index, which itself comprises 500 of the largest U.S. companies. In Buffett's words, the S&P 500 "mirrors a huge cross-section of American business, appropriately weighted by market value." The index tracks value stocks and growth stocks from all 11 market sectors, making it an excellent benchmark for the broader U.S. economy.
In plain English, the Vanguard S&P 500 ETF allows investors to diversify their money across a broad range of what are often blue chip stocks. That includes technology titans like Apple, consumer discretionary businesses like Amazon, healthcare giants like Johnson & Johnson, and financial companies like Visa.
The S&P 500 consistently outperforms most professional money managers
An S&P 500 index fund may lack the excitement of individual stocks, but it gets results. In fact, Buffett has often said the know-nothing investor can actually outperform most professional money managers by periodically buying an S&P 500 index fund. The data supports that theory. According to S&P Global, 93.4% of domestic large-cap funds underperformed the S&P 500 over the last 15 years. Put another way, the vast majority of fund managers do not beat the market.
Buffett once put his conviction to the test, wagering $500,000 that an S&P 500 index fund could outperform a set of actively managed hedge funds over a 10-year period. Ultimately, Buffett squared off against five hedge funds, each managed by a team of highly trained experts. The bet began in January 2008, the year the global financial crisis caused the stock market to crash, and ended in December 2017.
Long story short, Buffett won. His S&P 500 index fund trounced every single hedge fund. In fact, the best-performing hedge fund still underperformed the S&P 500 index fund by 38 percentage points, while the worst-performing hedge fund underperformed by 123 percentage points.
An S&P 500 index fund can turn patient investors into stock market millionaires
The Vanguard S&P 500 ETF produced a total return of 212% over the past decade, or 12% annually. At that pace, $100 invested weekly would grow into $91,000 in a decade, $374,000 in two decades, and $1.2 million in three decades.
Of course, $100 per week may be too much for some investors, and others may be able to contribute more. The chart below shows how different weekly contribution amounts would grow over the next 10 to 40 years, assuming a 12% annual rate of return (compounded).
| Amount contributed | 10 years | 20 years | 30 years | 40 years |
|---|---|---|---|---|
| $50 per week | $45,600 | $187,300 | $627,400 | $1.9 million |
| $75 per week | $68,400 | $281,000 | $941,100 | $2.9 million |
| $100 per week | $136,800 | $562,000 | $1.8 million | $5.9 million |
| $200 per week | $182,500 | $749,300 | $2.5 million | $7.9 million |
Table by author. Dollar totals assumed 12% compounded annual returns.
Here's the bottom line: The Vanguard S&P 500 ETF may be a boring investment. But it can help patient investors build multimillion-dollar portfolios without doing much work. It also bears a below-average expense ratio of 0.03%, meaning the annual fees on a $50,000 portfolio would total just $15. More importantly, the peace of mind the Vanguard ETF provides is priceless.
The S&P 500 has weathered several recessions and bear markets throughout history, but the index has never failed to recoup its losses. In other words, investors who hold the Vanguard ETF long enough are virtually guaranteed to profit.
