Investors often turn to Warren Buffett looking for stock tips, and he has given the same advice for years: Periodically put money into an S&P 500 index fund. Some readers may be surprised by that recommendation given that Buffett runs Berkshire Hathaway, but he has never actually recommended Berkshire stock to anyone.
Here’s how Buffett’s advice could turn $400 per month in $825,000 for patient investors.
An S&P 500 index fund is a basket of American businesses
The Vanguard S&P 500 ETF (VOO) is one of several good S&P 500 index funds. Like its benchmark, the fund tracks 500 U.S. companies that represent a blend of value stocks and growth stocks from all 11 stock market sectors. Its constituents cover 80% of the U.S. equity market and more than 50% of the global equity market, meaning investors that buy shares are effectively spreading money across many of the world’s most influential businesses.
The chart below shows the top 10 positions in the Vanguard S&P 500 ETF, which collectively account for 32% of its weighted exposure. The other 490 positions account for the remaining 68%.
CHART BY AUTHOR.
Warren Buffett wrote the following in his 2016 shareholder letter: “American business — and consequently a basket of stocks — is virtually certain to be worth far more in the years ahead.” That sentiment is the investment thesis for the Vanguard S&P 500 ETF.
The American economy is the largest and arguably the most innovative economy on the planet — 13 of the 15 largest companies in the world are U.S. companies — and spreading capital across a basket of American businesses has historically worked out quite well.
A time-tested investment strategy that has been profitable like clockwork
The S&P 500 has been a profitable investment over every rolling 20-year period since its inception in 1957, and its precursor (the Composite Stock Index) was a profitable investment over every rolling 20-year period since its inception in 1926. The profits are typically far from meager.
The S&P 500 produced an average 20-year return of 386% over the last decade, and the index soared 1,630% over the last three decades, compounding at roughly 10% annually. At that pace, $400 invested monthly in the Vanguard S&P 500 ETF would grow into $825,000 over the next three decades.
Some readers may not have $400 per month, and others may wish to contribute more. Assuming the S&P 500 continues to return 10% annually, the chart below shows how different monthly contributions would grow over the next one, two, and three decades.
An S&P 500 index fund can bring much-needed diversity to a portfolio of stocks
Some investors prefer index funds and others prefer individual stocks. Either is option is fine, but investors who lean toward individual stocks should consider supplementing their portfolios with an S&P 500 index fund like the Vanguard S&P 500 ETF. There are two reasons that strategy makes sense.
First, an S&P 500 index fund mitigates concentration risk. Investing in a few companies, or even a few sectors, can have catastrophic consequences if those companies or sectors perform poorly. An S&P 500 index fund offers broad-based diversity that makes catastrophic outcomes less likely.
Second, beating the S&P 500 is difficult. Less than 90% of large-cap funds outperformed the index over the last decade, meaning most professional investors would have done better by their clients if they’d simply bought an S&P 500 index fund. The same logic applies to individual investors.
Personally, I prefer a blended approach. I own dozens of growth stocks, but I also keep a substantial portion of my portfolio in the Vanguard S&P 500 ETF. I see it as a smart hedge. If my stocks beat the market, then my entire portfolio will beat the market. But I can rest easy knowing that, even if I’m wrong about every stock I own, the S&P 500 has been profitable like clockwork for patient investors.
— Trevor Jennewine
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Source: The Motley Fool