Warren Buffett has wowed us all for quite some time with his smart stock picks and market-beating portfolio. As chairman, he’s led Berkshire Hathaway to a more than 19% compounded annual gain over 58 years — that’s compared to a 10% such increase for the S&P 500 over that time period. Buffett believes in buying quality stocks that are undervalued, with the idea that the market will eventually recognize their potential. And he holds on for the long term to benefit.
This strategy has won over time, with Buffett scoring major gains from his biggest holding, Apple, as well as longtime favorites such as Coca-Cola and American Express. Today, Berkshire Hathaway’s portfolio is worth more than $279 billion. That’s compared to a value of about $107 billion a decade ago.
Buffett, though, doesn’t rely only on individual stocks for gains, and in fact, he says one particular investment — which isn’t an individual stock — always wins over the long run. He owns this type of asset and encourages other investors to include it in their portfolios, too. Let’s find out more and consider whether history supports Buffett’s idea.
Companies powering the economy
This Buffett-endorsed investment will help you benefit from the performance of not one but all of the biggest companies powering the day’s economy. I’m talking about an S&P 500 index fund. Buffett holds two in his portfolio: the SPDR S&P 500 ETF Trust (NYSEMKT: SPY) and the Vanguard S&P 500 ETF (NYSEMKT: VOO).
This sort of fund buys shares of each of the S&P 500 companies, with them weighted to the same degree in the fund as they are in the actual index. This way, the fund tracks the performance of the index. And when the index adds a new member, these funds will buy it in order to continue mirroring the index’s performance. For example, when Palantir Technologies joins the S&P 500 on Sept. 23, these funds will add the software company to their holdings. (At the same time, they’ll sell shares of any stocks exiting the index.)
This means the funds aren’t static but instead continually offer you exposure to the strongest companies of the time. Today, these companies, unsurprisingly, are in the area of information technology, with the industry accounting for 31% of the index and these funds. That said, these investments still offer you diversification. Eleven sectors are included, and of those, financials and healthcare also represent double-digit weightings.
When investing in ETFs, or exchange-traded funds, it’s important to look for those with an expense ratio of less than 1%, because an expense ratio that’s too high will eat into your returns over time. The SPDR and Vanguard S&P ETFs meet our criteria — at 0.09% and 0.03%, respectively.
Why Buffett likes this investment
Buffett likes index funds because they immediately offer an investor exposure “to a cross-section of businesses that in aggregate are bound to do well,” he once wrote in a shareholder letter.
And Buffett emphasized that he puts his money where his mouth is. Not only does he hold these ETFs right now, but in his will he instructs a trustee to put 90% of his cash into an S&P 500 index fund (and the other 10% in short-term government bonds).
The billionaire investor says that, over time, the S&P 500, representing a bet on American business, will win. And this is where history comes in. Let’s look at how the S&P 500 has done over the long term.
A look at the S&P 500 over the past 20 years shows difficult periods, but every time, the index has gone on to recover and gain. Even if you only held on to an index fund for five or six years, you would have seen a benefit — though, as shown by the longer-term performance, you’ll generally score the biggest victory if you keep this investment as part of your longest-term holdings.
So, history shows that Buffett is right about S&P 500 funds. Of course, a selection of carefully selected stocks could outperform the S&P 500 during any given time period. Buffett has proven that. But, like this famous investor, you could combine the two strategies — buying a selection of promising stocks and shares in an index fund — and set yourself up for growth and security down the road.
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American Express is an advertising partner of The Ascent, a Motley Fool company. Adria Cimino has positions in American Express. The Motley Fool has positions in and recommends Apple, Berkshire Hathaway, Palantir Technologies, and Vanguard S&P 500 ETF. The Motley Fool has a disclosure policy.
Warren Buffett Says This Investment — Present in His Portfolio — Always Wins Over Time. Here’s What History Tells Us. was originally published by The Motley Fool
