Warren Buffett is known for stock picking, selecting excellent long-term companies trading at reasonable or even dirt cheap prices and holding on for the long term. Using this strategy, he's helped Berkshire Hathaway's portfolio to achieve a compounded annual gain of almost 20% over the past 58 years. This is compared to the compounded annual increase of 10% for the S&P 500 index.
But Buffett also is a strong believer in another investing move that's a lot easier than stock picking -- it doesn't require research, specific knowledge of a particular company or industry, and it's proven itself to be a winner over time. In fact, Buffett owns this type of asset himself, an investment that complements his hand-picked stocks portfolio, and he's suggested that it's the ideal investment for a non-professional investor. If we use history as a guide, this asset could turn $300 per month into $1 million. Let's find out more.
Image source: The Motley Fool.
Betting on stock market leaders
So, what is this Buffett approved strategy? It's the investment in an S&P 500 Index fund, a move that allows you to bet on all of the companies currently fueling the U.S. economy. Buffett holds the SPDR S&P 500 ETF Trust (SPY 0.65%) as well as the Vanguard S&P 500 ETF in his portfolio -- both make great investments, but we'll use the SPDR fund as an example here.
These funds include the same companies found in the S&P 500 at the same weighting, and as a result, they track the performance of the index. Since the goal of the index is to measure the performance of major leaders of the times, stocks included are reviewed on a quarterly basis -- during those reviews, additions and deletions are announced. For example, this year the index invited high-growth technology companies Palantir Technologies and Super Micro Computer to join.
This means when you're invested in the S&P 500 through an index fund, you're always invested in the day's most prominent players -- and in fields that are making the biggest gains. For example, technology stocks, with a weighting of 32%, are the most heavily weighted in the index and in the funds that track it. The SPDR fund's top positions include Apple, Nvidia, and Microsoft, each representing more than 6% of the fund.
At the same time, these funds offer you a great deal of diversification, with positions in 10 other industries. This allows you to benefit from top players in many areas -- without having to become an expert in these companies and fields.
Advice from Warren Buffett
The goal of a non-professional investor should be "to own a cross-section of businesses that in aggregate are bound to do well," Buffett wrote in a shareholder letter several years ago. "A low-cost S&P 500 index fund will achieve this goal." (ETFs, or exchange-traded funds, come with fees, as seen in their expense ratio. You'll want one with a ratio of less than 1%, and the SPDR fits the bill, with a ratio of 0.09%.)
Now, all of this sounds great -- but how do we get to $1 million? This is through the magic of compounding, thanks to monthly investments in the fund along with commitment to doing this over time. We'll imagine you initially invest $5,000 in the SPDR S&P 500 ETF trust, then you invest $300 monthly over 35 years.
Historically, the S&P 500 has delivered an annual average return of about 10% since its beginnings as a 500-company index in the late 1950s. If this continues to be the case, your investment would total more than $1 million by the end of the 35-year investment period. Pretty good for a strategy that doesn't involve research or a time commitment -- only a monthly financial contribution.
Now, you might say, "what if I don't have $5,000 to invest up front or $300 to invest monthly?" -- don't worry. You can use this strategy even with a much smaller financial commitment and still potentially see significant growth. An initial investment of $500, for example, and monthly contributions of $200 could result in returns of more than $600,000 over the 35-year time period.
Though Buffett clearly has proven his strength as a stock picker, he still believes in investing in the S&P 500 to further increase his chances of winning. And the great news is you don't have to be an expert investor or a billionaire to add this move to your repertoire -- and like Buffett, potentially grow wealth over the long term.
