Warren Buffett, who took control of Berkshire Hathaway six decades ago, has earned a reputation as one of the greatest investors in American history. He has consistently given the same advice: Buy an index fund that tracks the S&P 500 (^GSPC 1.52%)
"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 suggested the Vanguard S&P 500 ETF (VOO 1.53%).
Here's how that advice could turn $400 invested monthly into $835,000 over 30 years.
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The Vanguard S&P 500 ETF provides exposure to many of the most influential companies in the world
The Vanguard S&P 500 measures the performance of the S&P 500, which 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.
The index fund provides exposure to many of the most influential businesses in the world. The top 10 positions are listed by weight below:
- Nvidia: 8.4%
- Apple: 6.8%
- Microsoft: 6.5%
- Alphabet: 5%
- Amazon: 4%
- Broadcom: 3%
- Meta Platforms: 2.4%
- Tesla: 2.1%
- Berkshire Hathaway: 1.5%
- JPMorgan Chase: 1.4%
One risk associated with owning an S&P 500 index fund is the extraordinary concentration of the underlying index. The top 10 companies account for 41% of the S&P 500 by market-cap weight, which means a large decline in two or three of those stocks could really drag on the entire index.
However, the top 10 companies also account for approximately 33% of the S&P 500's earnings, so the statistic is not as alarming as many pundits make it out to be. Their price-to-earnings multiples are above average, but their strong competitive positions warrant premium valuations.
Warren Buffett likes S&P 500 index funds because they have regularly generated attractive returns over long periods
There is a simple reason Warren Buffett believes an S&P 500 index fund is the best way for the average investor to get stock market exposure: Buying individual stocks requires more work than most people are willing to take on, and beating the S&P 500 is challenging even for professional money managers.
Indeed, fewer than 15% of large-cap fund managers outperformed the index during the last decade. That means most professionals would have been better off buying an S&P 500 index fund. And if that many trained experts struggle to outperform the index, then most non-professional investors are likely to fail.
"The goal of the non-professional should not be to pick winners," Buffett wrote 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."
Another reason to like S&P 500 index funds is that the underlying benchmark has consistently been a profitable investment over long periods. In fact, the S&P 500 has never produced a negative return over any 15-year period since its inception in 1957.
History says the Vanguard S&P 500 ETF can turn $400 invested monthly into $835,000 over three decades
The S&P 500 returned 1,810% in the last three decades, compounding at 10.3% annually. That period encompasses such a broad range of economic and market conditions that similar results are plausible over the next three decades.
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Key Data Points
At that pace, $400 invested monthly in an S&P 500 index fund would be worth $77,000 after one decade, $284,000 after two decades, and $835,000 after three decades. Moreover, the Vanguard S&P 500 ETF has a very low expense ratio of 0.03%, meaning shareholders will pay $3 annually on every $10,000 invested in the fund.
Brendan McCann at Morningstar writes, "This exchange-traded fund accurately represents the large-cap opportunity set while charging rock-bottom fees, a recipe for success over the long run." Indeed, you would be hard-pressed to find a cheaper index fund with a better track record.
As a final thought, investors need not choose between individual stocks and an S&P 500 index fund. For those willing to do the research, owning both is a smart strategy. If your stocks outperform, your portfolio will beat the S&P 500. But if your stocks underperform, your portfolio will not trail the S&P 500 too badly (depending on what percentage of your money is invested in an S&P index fund).
