Warren Buffett is worth more than $131 billion. He built his fortune by consistently investing in the right companies throughout his decades-long career. But Buffett advises the average person not to try to pick stocks like him.
“In my view, the best bet for most people is to own an S&P 500 index fund,” he said at a Berkshire Hathaway conference in 2020. But why?
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The power of time
Despite his success, Buffett has made many investing mistakes throughout his career, and he says these mistakes can be traced back to the very first stock he bought.
According to Yahoo Finance, Buffett first invested in the stock market when he was 11 years old. In 1942, he bought stock in a company he liked for $114.75 a share, which is roughly $2,200 in today's value.
Buffett didn't discuss how his investment performed, but he said he wished he'd put the money in a low-cost S&P 500 index fund. If he had done so and not sold, his $114.75 investment would be worth more than $400,000 today.
Buffett said this story shows just how much the US stock market can grow over one person's lifetime, which is why he wants 90% of his fortune invested in a very low-cost S&P 500 index fund after he passes away.
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Buffett: Ordinary people can't pick stocks
“I don't believe that ordinary people can pick stocks,” Buffett told Berkshire Hathaway investors at the company's 2021 annual meeting. This is the crux of why he recommends most people invest in an S&P 500 index fund. To understand why, let's take a quick look at what the S&P 500 is.
This index tracks the performance of the 500 largest publicly traded companies in the United States. It represents 80% of the US stock market. So when you buy the S&P 500, you're essentially investing in the growth of the US economy over the long term. History has proven that this is a good bet.
How to invest in the S&P 500 like Buffett
Buffett knows from experience how difficult it is to buy an index fund and hold it for decades, which is why he tells investors today: “Don't buy it with the intention of selling it in two or three years and making a profit,” pointing out that selling too soon could end up costing you money.
So the first step to investing like Buffett is to adopt a long-term mindset. Over the past 150 years, the S&P has averaged a 9.24% annual return. Even if you lose money for a few years, your investment should grow substantially over the long term.
Buffett also says it's important to choose an S&P 500 fund with low fees. Even a one percent difference in brokerage commissions can significantly reduce your stock market returns over time. To understand why, consider the following assumptions:
Let's say you invest $1,000 in the S&P 500 today and invest an additional $50 each month for the next 40 years. The index's historical average is 9.24%, so we'll assume an average annual return of 9.24%.
Now, let's say you have a choice between two S&P 500 funds with fees of 1% and 2%, respectively. By simply choosing the fund with the 1% fee, you'll end up with roughly $50,000 more after 40 years.
So the second rule of investing in the S&P 500 like Buffett is to shop around for the best interest rate. As this theory shows, small differences can add up to big results between now and when you want to retire.
Which S&P 500 ETF should you choose?
If you're ready to follow Buffett's advice and invest in the S&P, the next step is to choose an ETF. The two most popular options are State Street SPDR S&P 500 ETF (SPY) and Vanguard S&P 500 ETF (VOO).
SPY has the highest trading volume and assets under management. But when you consider costs over the long term, VOO is the better choice. VOO has an expense ratio of 0.03%, while SPY costs 0.0945% per year. If your brokerage gives you access to VOO, Schwab S&P 500 Index Fund (SWPPX) is an even better choice, with an expense ratio of just 0.02%.
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This article originally appeared on GOBankingRates.com: Warren Buffett: How investing in the S&P 500 can get you rich
