Warren Buffett is arguably the most successful stick picker in the world. So if you are thinking of investing your $ 1,400 stimulus check, you should follow his advice.
Surprisingly, however, Buffett doesn’t think most people should pick their own stocks. The Omaha Oracle believes the average investor should seek “a cross section of companies that are doing well overall,” he wrote in his 2013 annual letter to Berkshire Hathaway shareholders. “An affordable S&P 500 Index fund will achieve this goal. “
Buffett believes in S&P 500 funds so much that he has directed the trustee of his estate to put 90% of his money in S&P 500 funds for his wife when he dies. The remaining 10% goes into short-term treasury bills.
Here is the 411 on S&P 500 index funds and why they are a great option when looking to invest in your stimulus check.
What is an S&P 500 index fund?
The S&P 500 is a stock index that tracks the performance of stocks issued by 500 companies in the United States. (The S&P 500 actually contains 505 stocks, as five of the companies – one of which is Buffett’s Berkshire Hathaway – issue two classes of shares.)
It is the most widely used stock index in the US, followed by the Dow Jones Industrial Average and the Nasdaq. When you hear on the news that stocks have gone up or down, it often means that the aggregate prices of those 505 stocks in the S&P 500 were trending up or down.
An S&P 500 index fund is a pool of stocks that replicates the S&P 500. If you buy a single stock, you are automatically invested in all 500 companies. When the S&P 500 is up and running, the value of your investment increases. If the index is down, so will your investment.
You can find S&P 500 funds, which are exchange traded funds (ETFs) that trade on exchanges like individual stocks, or mutual funds that you buy from an investment company.
Advantages and Disadvantages of Investing in an S&P 500 Index Fund
Here are the pros and cons of S&P 500 index funds. Spoiler alert: there are a lot more pros than cons, especially if you’re a beginner.
S&P 500 Index Fund Pros
- With a single investment, you automatically get one diversified portfolio. That’s a fancy way of saying that instead of putting all your eggs in one basket, you’re spreading your risk. You are invested in 500 companies in 11 different industries. For this reason, investing in an S&P 500 index fund is much less risky than investing in the stocks of individual companies.
- The S&P 500 delivers reliable long-term returns. Over the past 30 years, the S&P 500 has had an average annualized return of just under 8% after you factor in inflation. That doesn’t mean you can’t lose money. The S&P 500 fell more than 50% during the Great Recession from 2007 to 2009. Historically, however, the index has rallied over the long term.
- Your fees are minimal. Because you don’t pay professionals to choose investments for you, the investment costs are low. Many S&P 500 index funds have an expense ratio of less than 0.1%, which means that less than 0.1% of your investment is spent on non-investment costs. If you invest $ 1,000 in a 0.1% expense ratio fund, $ 999 of your money will go into the actual investment.
- Passive management usually beats active management. Don’t let the idea of sitting back and letting your money roll with the entire S&P 500 scare you. After fees, most active managers underperform index investments, often referred to as passive management.
- You invest in large companies with a profitable track record. To be included in the S&P 500, a company must have a market capitalization of $ 9.8 billion, which is the total outstanding value of all of its stocks. You must also have at least four consecutive profitable quarters behind you. If a company gets into financial trouble, it risks being delisted.
S&P 500 Index Fund Cons
- There is less potential for great rewards. One disadvantage of investing in an index fund is that you don’t have the potential to hit the jackpot by picking the next Netflix. You won’t outperform the market either, as the fund’s performance moves with the S&P 500’s performance.
- The S&P 500 focuses heavily on a few giants. Yes, you become an investor in 500 companies when you buy an S&P fund. However, because the index is weighted by market capitalization, your money will not be evenly distributed among these companies. Only five tech companies account for 15% of the S&P 500’s value: Apple, Microsoft, Amazon, Facebook, and Google’s parent company Alphabet. For much of 2020, that number was over 20%. While these companies’ share prices have risen sharply, there is also a risk that the tech sector will disproportionately affect the overall index if it falters.
- Big companies have less room for growth. The S&P 500 companies are among the most successful and stable in their respective industries. One disadvantage: they are already so big that they have less space to grow. Small-cap stocks, or stocks with a market cap less than $ 2 billion, usually have the greatest potential for growth, although they are also much riskier.
What is the best S&P 500 index fund?
There is no such thing as a “best” S&P 500 index fund. They’re made up of the same investments and deliver pretty much the same returns. And you don’t need to own more than one S&P 500 index fund, as they all track the same index.
The main thing to focus on is low fees. Look for an expense ratio of 0.1% or less. Choosing a fund with a low minimum upfront investment is also a good choice. With ETFs, the cost to start investing is the price of a single share, while mutual funds often require an upfront investment of $ 1,000-2,000.
Some options that we don’t like in any particular order are the SPDR S&P 500 ETF Trust (SPY), the Vanguard S&P 500 ETF (VOO), the iShares Core 500 ETF (IVV), and the Fidelity 500 Index Fund ( FXAIX).
One final tip from Mr. Buffett: don’t invest all of your money at once. Practice dollar cost averaging, which means making regular investments at set intervals, which will typically get you the best price for your investments in the long run. For example, with your stimulus check, you could deposit the check and invest $ 350 per month for four months.
If you are considering investing your stimulus check, do so only if you have an emergency fund, no high-yield debt, and no bills to contend with. However, if you can afford to invest that money, S&P 500 funds are a great way to grow your $ 1,400 growth.
Robin Hartill is a certified financial planner and senior writer at The Penny Hoarder. She writes the Dear Penny personal finance advisory column. Send your tricky money questions to [email protected]