There are few financial experts on the planet with a better reputation for picking winners than Warren Buffett. And one type of investment the former CEO of Berkshire Hathaway says is ideal for beginners is an exchange-traded fund (ETF).
Here's what you need to know
ETFs hold a collection of assets, including stocks, bonds, and commodities. Just like regular company stocks, ETFs are bought and sold on public stock exchanges. What sets an ETF apart from the crowd is the way they give you exposure to dozens, hundreds, or even thousands of assets. In other words, you're not putting all your eggs in one basket, and you're spreading your investment risk.
Image source: Getty Images.
What Buffett has said about ETFs
In a 2013 Berkshire Hathaway shareholder letter, Buffett wrote: "The 'know-nothing' investor who both diversifies and keeps his costs minimal is virtually certain to get satisfactory results. Indeed, the unsophisticated investor who is realistic about his shortcomings is likely to obtain better long-term results than the knowledgeable professional who is blind to even a single weakness."
Rather than researching individual companies when you may not feel equipped to choose the "right" ones, you can buy into an entire portfolio of shares with a single trade. Not only do ETFs spread your risk, but lower fees also leave you with more money to invest.
What Buffett likes about ETFs
One can summarize Buffett's investment philosophy by highlighting the three factors he believes can build wealth:
- Diversification: ETFs fit the bill simply by including a wide range of stock types (and other assets) in a single investment.
- Low fees: ETFs -- particularly those that track broad market indexes -- typically come with significantly lower fees than actively managed funds. Over the long term, those savings only add to your portfolio's value. Examples of the broad-market indexes include the S&P 500, Dow Jones Industrial Average, Russell 2000, and MSCI World index.
- Long-term compounding: According to Buffett, his investing style has always relied on compounding. He doesn't buy something only to sell it, but rather buys with the intention to hold it for decades. This long-term approach gives an investment time to benefit from the power of compounding returns and steadily grow, despite occasional market downturns.
Sample of ETF types
There are all kinds of ETFs, depending on your goals. For example:
- Broad market ETFs: Track the performance of a broad market index, as mentioned above.
- Sector-specific ETFs: Track companies in economic sectors such as healthcare, finance, or technology.
- International and global ETFs: Track high-performing stocks from companies outside the U.S.
- Thematic ETFs: Track specific investment themes, such as robotics or artificial intelligence (AI).
- Bond ETFs: Track various types of bonds, including government, municipal, and corporate.
- Commodity ETFs: Track physical commodities, such as gold, oil, and agricultural products.
Whether you're a novice investor or simply want to provide your portfolio with greater diversification, you may want to heed Buffett's advice by taking a closer look at ETFs.
