Warren Buffett, who six decades ago took control of Berkshire Hathaway, has earned a reputation as one of the greatest investor in American history. And he has consistently given the same advice: Buy an index fund that tracks the S&P 500 (^GSPC 0.26%)
"In my view, for most people, the best thing to do is to own the S&P 500 index fund," Buffett told attendees at Berkshire's annual meeting in 2021. He has specifically suggested the Vanguard S&P 500 (VOO 0.23%).
Following that advice could turn $500 invested monthly into $986,600 over 30 years. Here's what investors should know.
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The pros and cons of the Vanguard S&P 500 ETF
The Vanguard S&P 500 ETF measures the performance of the S&P 500, which itself tracks 500 large U.S. companies. It includes value stocks and growth stocks from all 11 stock market sectors, and covers about 80% of domestic equities and 40% of global equities by market value.
In short, the Vanguard S&P 500 ETF provides exposure to many of the most influential companies in the world. The top 10 positions are listed by weight as follows:
- Nvidia: 7.7%
- Microsoft: 6.8%
- Apple: 6.3%
- Alphabet: 4.1%
- Amazon: 3.9%
- Meta Platforms: 2.9%
- Broadcom: 2.5%
- Tesla: 1.7%
- Berkshire: 1.6%
- JPMorgan Chase: 1.4%
One risk associated with owning an S&P 500 index fund is the extraordinary concentration of the underlying index. Just 10 companies account for 29% of the S&P 500 by market-cap weight, which means a big decline in a few of those stocks could sink the index. However, those companies also account for about 33% of the S&P 500's earnings, so the statistic is not as alarming as many pundits make it out to be.
Why Warren Buffett likes S&P 500 index funds
There is a simple reason Warren Buffett thinks an S&P 500 index fund is the best way for the non-professional investor to get exposure to the stock market: Buying individual stocks requires more dedication that most people are willing to commit, and achieving better returns than the S&P 500 is very challenging.
Indeed, fewer than 15% of large-cap fund managers outperformed the index during the last decade. That means most professional money managers would have been better off buying an S&P 500 index fund. And if that many trained experts struggle to beat the index, then most non-professional investors are likely to fail, too.
"The goal of the non-professional should not be to pick winners," Buffett warned in his 2013 shareholder letter. They should instead seek to "own a cross-section of businesses that in aggregate are bound to do well. An S&P 500 index fund will achieve this goal."
Additionally, the S&P 500 has consistently been a profitable investment over long intervals. The index never produced a negative return over any 15-year period since its inception in 1957. In other words, investors that bought an S&P 500 index fund at any point in the last 68 years has made money, so long as they held the index fund for at least 15 years.
How the Vanguard S&P 500 ETF could turn $500 per month into $986,900
Including dividends, the S&P 500 returned 1,860% in the last three decades, compounding at 10.4% annually. That period encompasses such a broad range of economic and market conditions that similar results are plausible over the next three decades. But I will assume a slightly more conservative return of 10% annually to introduce a margin of safety.
At that pace, $500 invested monthly in an S&P 500 index fund would be worth $95,600 after one decade, $343,600 after two decades, and $986,900 after three decades. You would be hard pressed to find a cheaper index fund with a better track record.
Importantly, the Vanguard S&P 500 ETF has a low expense ratio of 0.03%, meaning shareholders will pay just $3 annually on every $10,000 invested in the fund. Brendan McCann at Morningstar recently wrote, "This exchange-traded fund accurately represents the large-cap opportunity set while charging rock-bottom fees, a recipe for success over the long run."
As a final thought, investors need not choose between individual stocks and an S&P 500 index fund. For those willing to do the requisite research, owning both is a smart strategy. Your portfolio will beat the market if your individual stocks outperform, but will not trail the market too badly if your individual stocks underperform. Think of an S&P 500 index fund as a sort of safety net that tethers your return to the entire U.S. stock market.
