Warren Buffett is one of the greatest investors in American history. His uncanny ability to pick winning stocks helped Berkshire Hathaway build a $318.6 billion portfolio, nearly two-thirds of which is unrealized capital gains. Moreover, Berkshire has become one of the largest companies in the world under his leadership, its value growing twice as fast as the S&P 500 since he took control in 1965.
Those accomplishments make Buffett an excellent source of investing advice, and one recommendation stands out from the rest: 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.
Here's why.
The S&P 500 provides diversified exposure to the U.S. stock market
The Vanguard S&P 500 ETF (VOO 1.00%) is one of three good S&P 500 index funds. It tracks 500 large-cap American companies, including growth stocks and value stocks from all 11 market sectors. It covers approximately 80% of the U.S. equities market based on market capitalization, making it a good benchmark for the broader U.S. economy, which happens to be the largest and (arguably) the most innovative economy on the planet.
The five largest holdings in the Vanguard S&P 500 ETF are:
- Microsoft: 7.1%
- Apple: 7.1%
- Alphabet: 3.9%
- Amazon: 3.4%
- Nvidia: 2.9%
An S&P 500 index fund essentially lets investors diversify capital across many of the most influential companies in the world. Warren Buffett sees that diversity as a compelling reason to invest. He once described the S&P 500 as a "cross-section of businesses that in aggregate are bound to do well."
The S&P 500 regularly outperforms most large-cap fund managers
There is another reason Buffett is so fond of S&P 500 index funds. He believes the know-nothing investor can actually beat most professional money managers by periodically buying shares of a product like the Vanguard S&P 500 ETF.
Historical data backs that assertion. Just 13% of large-cap funds managed to beat the S&P 500 over the last five years, and only 8% outperformed the index over the last 15 years, according to S&P Global. In other words, investors who buy and hold the Vanguard S&P 500 ETF have a good shot at beating the great majority of professional money managers.
The S&P 500 consistently created wealth throughout history
There is no such thing as risk-free stock market exposure, but the S&P 500 is the next best thing. The index has been a profitable investment over every rolling 20-year period since its creation in 1957, and its precursor was profitable over every rolling 20-year period since its creation in 1926. That means investors who buy shares of the Vanguard S&P 500 ETF are virtually guaranteed to turn a profit if they hold their shares long enough.
Indeed, the S&P 500 soared 1,650% over the last three decades, or 10.01% annually. At that pace, $450 invested monthly in an S&P 500 index fund would be worth $90,000 in 10 years, $323,600 in 20 years, and $930,000 in 30 years.
Of course, some investors may not be able to afford $450 per month, and others may want to save more. The chart details how different monthly contributions would grow over time if invested in an S&P 500 index fund, assuming an annualized compounded return of 10.01%.
|
Holding Period |
$200 Per Month |
$300 Per Month |
$600 Per Month |
|---|---|---|---|
|
10 years |
$40,000 |
$60,000 |
$120,000 |
|
20 years |
$143,800 |
$215,700 |
$431,500 |
|
30 years |
$413,400 |
$620,000 |
$1.2 million |
Chart by author. Notes: Dollar totals rounded to the nearest $100. Change in value is based on a compounded return.
The 50-30-20 rule provides a good framework for investors
Most financial advisors recommend following the 50-30-20 rule, which stipulates that 50% of income should be spent on essential items or needs, 30% should be spent on discretionary items or wants, and 20% should be saved or used to pay off debt.
The median American worker's annual salary was about $58,000 during the third quarter, according to the Labor Department. Conservatively assuming taxes take 30% of that total, the median American worker is left with about $40,000 per year. The 50-30-20 rule says $8,000 of that total should be saved, which is roughly $667 per month.
In that context, investing $450 per month in an S&P 500 index fund should be achievable for many workers. Those who cannot afford that sum should save what they can, and those with money left over should consider buying individual stocks.
