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An investment move “that makes the most sense practically all of the time”?
While you might be wondering if such a thing even exists, investor extraordinaire Warren Buffett says it’s as easy as buying shares of a single mutual fund. Just make sure it’s an S&P 500 index fund and one that charges low fees.
As billionaire Buffett, CEO of Berkshire Hathaway, once told CNBC’s “On the Money“:
“… consistently buy an S&P 500 low-cost index fund. Keep buying it through thick and thin, and especially through thin. … American business is going to do fine over time …”
Why you should invest in index funds
Everyone from Buffett to Money Talks News founder Stacy Johnson lauds index funds partly because they offer both diversification and low fees. But let’s start at the beginning.
As we explain in “Money Lingo You Need to Know for Financial Survival,” a mutual fund is a pool of multiple investments such as stocks or bonds. So mutual funds offer “built-in” diversification, which is why investing in a mutual fund is considered less risky than investing in a single company’s stock or a single bond.
There are two main breeds of mutual funds in terms of how they are run: actively managed funds and passively managed funds, also known as index funds.
Active funds are generally managed by a human who tries to beat the performance of a financial market or index.
Index funds are generally managed by computers because they simply try to match the performance of a financial market or index. An S&P 500 index fund, for example, tries to match the performance of the Standard & Poor’s 500, which is a stock market index comprising 500 of the largest American companies.
As a result of how they are run, index funds tend to charge lower fees than active funds.
Advocates practice what they preach
It’s worth noting that experts who preach the value of index funds also invest in them.
Buffett made headlines in 2014 for writing in his annual letter to Berkshire Hathaway shareholders about a bequest he included in his will. In the letter, Buffett talked about cash he will leave to his wife when he dies. The money will be delivered to and handled by a trustee. Buffett writes:
“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.”
Buffett also put his money on the Vanguard 500 Index Fund, an S&P 500-tracking fund offered by the Vanguard Group, when he made a 10-year bet against hedge fund managers.
As we reported in January, Buffett won that bet by a huge margin, adding more weight to his argument that index funds are the best way to invest.
In “Ask Stacy: How Do I Invest in the Stock Market?” Stacy writes that the stock mutual fund he personally uses in his retirement account is the Vanguard 500 Index Fund. He notes that it is one of the largest and most popular in the world.
Low fees — such as those associated with most index funds — are critical for building a nest egg that’s big enough to last as long as you do. As Buffett told CNBC:
“If returns are going to be 7 or 8 percent, and you’re paying 1 percent for fees, that makes an enormous difference in how much money you’re going to have in retirement.”
What’s your take on index funds? Share your thoughts or experiences below or on Facebook.