“Steady as she goes” beats trendier, more volatile investment options for Warren Buffett and many other market watchers
An S&P Index Fund is not the most exciting investment vehicle around, but it has proven its worth repeatedly. When markets do “crazy things,” as they sometimes do, investment giant Warren Buffett swears by companies that “will stand the test of time.” For Buffett, having a solidly balanced portfolio and long-term plan means being willing “to look unimaginative” or “even to look foolish” for “a sustained period.”
When the stock market reaches new highs daily, and the economy is hot, it’s tempting for many investors to stray from the tried and true into the realm of high-growth startups, cryptocurrencies, or the newest celebrity-backed special purpose acquisition company (SPAC) initial public offering (IPO). The allure of quick wins is undeniable. But the risk involved can be considerable—and taking on too much of it can derail a carefully crafted investment plan.
In Buffett’s words, delivered during the 2020 Berkshire Hathaway shareholder’s meeting, “for most people, the best thing to do is to own the S&P 500 index fund.” The “Oracle of Omaha” practices what he preaches: It’s reported he instructed the trustee who manages his estate to invest 90% of his money into S&P 500 index funds for his widow.
A consistent track record
The initial Standard & Poor’s Index was created in 1926 with only 90 stocks, chosen to represent the performance of the U.S. stock market’s largest companies. The index was expanded and renamed in 1957 as the S&P 500 Stock Composite Index to include 500 companies based on market capitalization.
Market capitalization measures a company’s value based on its number of publicly available shares and its stock price. The S&P 500 tracks the largest companies listed on U.S. stock exchanges across 11 major sectors ranging from information technology to energy. It’s considered a more accurate economic index than the Dow Jones Industrial Average, which tracks only 30 “blue-chip” companies.
Since 1926, the S&P 500 has weathered numerous downturns and corrections along with the market, but its annual return rate averages around 10 percent. Like all securities, an S&P 500 index fund is vulnerable to short-term losses in a volatile economy, but given enough time, it has always recovered. The index has thus earned a reputation as a reliable investment vehicle for investors who plan to keep their money in the market for a long time. S&P 500 index funds are considered a particularly sensible option for retirement plans.
Other benefits of choosing the S&P 500
Warren Buffett is not alone in his praise of S&P 500 index funds. Investment advisors and market watchers across the globe promote the index as a benchmark and consistently view the U.S. market as a “safe haven with the potential for good growth.” Moreover, its inclusion of high-growth companies within the past 20-30 years, along with a stringent quarterly qualification process, help ensure the index reflects many of the highest-performing publicly traded companies currently in the U.S.
Investing in the S&P 500 gives an individual the benefit of not only the performance of the largest-cap stocks but also the dividends that companies within the index distribute. And typically, S&P 500 index funds are offered with fewer fees that significantly impact realized returns over time. With disciplined planning, longer-term holdings in a passively managed index fund can also trigger fewer taxes.
The allure and risk of trendier options
Investors are currently borrowing to invest in stocks at record levels, and much of this trend is driven by enthusiasm for “hot” investments. There is nothing new about the power of hype in investment communities. But according to a recent study by researchers at the Institute of New Economic Thinking at the Oxford Martin School, what’s changed is the immediacy granted by social media platforms to the “next biggest thing.”
Market watchers point to the power of “contagion and consensus” found online, such as in the subreddit WallStreetBets. Often, the two combine to drive an asset’s popularity to the point it obscures its fundamentals, as was demonstrated by the “meme stock” phenomenon of early 2021.
The study of how social media dynamics influence investor behavior and stock prices is very new. And while researchers are finding it difficult to prove causality between online hype and market behavior definitively, the volatility that accompanies the rise of a “meme stock” has been demonstrated.
The most convincing argument for not putting most money in an S&P 500 Index fund is also simple: investors will never beat the market. Index funds are designed to match what the market is doing, for better or for worse. You are certainly not guaranteed against loss, and there is no opportunity to experience possible outsized gains of picking “winning” stocks.
Nevertheless, passive investing has significant virtues. It’s the easier and the less stressful choice for many investors, and it aids a long-term perspective. Index funds are viewed as more stable than active funds, which are more likely to be influenced by subtler market changes, trends, and actively managed choices. While all investing carries some risk, the passive nature of funds that track a broad index can mean less risk over time and lower fees and expenses.
In the end, every investor’s situation—including objectives, lifestyle, and stage of life—is different. But the wisdom of sufficiently diversifying a portfolio and creating a customized, long-term plan is universal. This is one reason an S&P 500 index fund remains a mainstay for investing in securities. And when the highly successful Warren Buffett endorses a strategy, many investors listen.
Lindberg & Ripple features a team of experienced wealth advisors who can assist with managing the complexities of wealth. We’ll help you develop and maintain a customized strategy designed to grow and preserve wealth for future generations. Contact us to learn more.