On page 20 of a 2013 letter to shareholders, Berkshire Hathaway’s Chairman and CEO Warren Buffett, an individual who knows quite a bit about successful investing, wrote:
“My advice to the trustee could not be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. (I suggest Vanguard’s.) I believe the trust’s long-term results from this policy will be superior to those attained by most investors – whether pension funds, institutions or individuals – who employ high-fee managers.”
In other words, the “Oracle of Omaha” advises that a broadly diversified market-cap-weighted index fund is a valuable starting point for all retail investors.
Index funds are typically lower cost mutual funds or Exchange-Traded Funds (ETFs) that passively track the performance of the benchmark index. For example, an S&P 500 Index mutual fund or ETF would hold the same stocks that are in the widely followed S&P 500 stock market index.
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The S&P 500 Fund is a stock market index that tracks the stocks of 500 large-cap U.S. companies. Over the last 10 years, the S&P 500 has returned 9.49 percent per year. In 2017, it returned 21.83 percent. S&P stands for Standard and Poor, the names of the two founding financial companies.
These 500 Index Funds are typically a low-cost way to gain diversified exposure to the U.S. equity market. These funds offer exposure to 500 of the largest U.S. companies, which span many different industries and account for about three-fourths of the U.S. stock market’s value.
The S&P 500 only measures large-cap U.S. stocks and is often used as a leading economic indicator of how well the U.S. economy is currently doing or may due in the coming six to twelve months. If investors are confident in the economy, they will buy stocks. Some experts believe the stock market can predict what the savviest investors think the economy will do in about six months.
The key take-away regarding index fund investing comes again from the investment wisdom of Warren Buffett. In Berkshire Hathaway’s 2013 letter to shareholders, he wrote on page 20 that “…The typical investor doesn’t need this skill [the ability to predict their future earning power of specific businesses five years out]. In aggregate, American business has done wonderfully over time and will continue to do so (though, most assuredly, in unpredictable fits and starts). In the 20th Century, the Dow Jones Industrials index advanced from 66 to 11,497, paying a rising stream of dividends to boot. The 21st Century will witness further gains, almost certain to be substantial. The goal of the non-professional should not be to pick winners – neither he nor his “helpers” can do that – but should rather be to own a cross-section of businesses that in aggregate are bound to do well. A low-cost S&P 500 index fund will achieve this goal.”
Sources:
- https://www.thebalance.com/what-is-the-sandp-500-3305888
- Warren Buffett, Letter to Shareholders, 2013 Annual Report, Berkshire Hathaway, Inc., pg. 20