Learn why Warren Buffett famously said that the best investment for individual investors is the S&P 500 because “there’s been no better bet than America.”


The Oracle of Omaha

In an interview with CNBC in early 2019, Warren Buffett explained his view that the S&P 500 is the best investment for individual investors in the US. It was one of the most fascinating and enlightening interviews I’ve seen.

As you may know, Warren Buffett is the Oracle of Omaha. He built Berkshire Hathaway, which is a conglomerate that owns a significant share of about 60 of American companies you have definitely heard of. Companies like GEICO, Duracell, and Dairy Queen. His personal net worth is above about $80 billion, and Berkshire Hathaway is currently the 7th largest company in the S&P 500.

During the interview, he discussed what he calls “the American tailwind,” which is the phenomenon of massive, continued, long-term growth and innovation in American business. He explained what it is, and how individual investors can take advantage of it.

The rest of this article explains the American tailwind, what it means for your investments, how to invest in the S&P 500, and what to never invest in.

Enjoy!



The American Tailwind

Time is a weird thing.

Y2K was already 20 years ago. The moon landing was 50 years ago. And, 77 years ago, Warren Buffett bought his first stock. He bought three shares of Cities Service Preferred for $114.75.

During his interview on CNBC, he shared a little math. If, instead of buying Cities Service Preferred, he had just bought an S&P 500 Index Fund (which, didn’t exist yet, but this is hypothetical), his $115 would have turned into over a half-a-million dollars (about $575,000).

Basically, over the 77 years Warren Buffett has been investing, a dollar in the S&P 500 has grown to $5,000. And, what if he had started with a million?

“That $1 million would’ve turned into $5.3 billion. You would’ve gotten– for every dollar you put in you’ve gotten over $5,000 without ever reading a headline, an annual report. You didn’t have to know accounting, you just had to believe in America. And you didn’t have to pick the right stock, you just picked America. And if that isn’t a tailwind– it’s more like a hurricane.Warren Buffett – Interview on CNBC 2/25/2019.

He went on to point out that there have only been three 77-year periods since George Washington was inaugurated. As he puts it, the US economy went from essentially nothing to about $110 trillion in household wealth, in just three lifetimes.

That is incredible.

Participating in Growth

Wealth and income distribution has always been lopsided. And, during my lifetime, wealth inequality has definitely increased. There are economic and political reasons that this has happened, and certainly there are things that can or should be done to address it. But, that’s a soapbox for another day.

Yes, it is hard to become wealthy. But, it’s not impossible. It is not illegal. And, you don’t need a King to make you a Noble. You can acquire capital all by yourself, and that’s pretty awesome.

Sure, it is popular to say “the rich keep getting richer.”

But, I prefer to say, “owners keep getting paid for what they own.”

The difference is more than semantics. Sure, it is tough to become one of these “rich” people who keep getting richer. But, it really isn’t that difficult to become an owner. And, it turns out, being an owner is what makes the rich get richer.

We know that the US economic engine is generating trillions of dollars in corporate profits each year. And, those companies are constantly innovating and changing to find new products and services for us to buy. Wouldn’t it be great if you could own at least some part of these great, innovative companies? Then you would be entitled to a portion of those profits!

Well, I have amazing news for you. You can own as much of the American economic engine as you want.

That is where the S&P 500 comes in.


What is the S&P 500?

The S&P 500 is simply a list of the 500 largest and most successful publicly traded companies in the US. If you saw the full list, you would probably recognize nearly every brand.

Currently, the S&P 500 includes Apple, Microsoft, Amazon, Facebook, Tesla, Google, Berkshire Hathaway, Johnson & Johnson, Chase, Visa, Mastercard, Disney, Home Depot, Paypal, Verizon, Netflix, Comcast, Bank of America, AT&T, Coke, Intel, Walmart, Costco, and many more.

When you invest in the S&P 500 index, you become a part owner in all 500 of these companies. And, instead of buying an equal share in each of them, your investment is weighted based on their size. So, you buy more of the biggest one and less of the smallest one. For example, the largest company in the S&P 500 today is Apple, at almost 7% of the index. And, the smallest is Under Armour, at about 0.02%.

That means, if you invested $1,000 in the S&P 500 today, you would get about $70 of Apple stock and about $0.20 worth of Under Armour.

And, it is worth noting, about $14 of your $1,000 would be in Warren Buffett’s Berkshire Hathaway.

More importantly, you are now a part owner of each of the 500 largest and most successful companies in the US. And, that means when they profit, you profit.

Owners get paid for what they own.


How to Invest in the S&P 500

The best way to invest in the S&P 500 is with a low-cost index fund. There are lots of options, and whichever investment company you use will definitely have at least one available.

Personally, I invest in more than just the S&P 500. If you’ve read many of my articles, you know that I use the FidelityGo RoboAdvisor. That means that I have exactly six investments:

  1. Large Cap Stock (S&P 500 Index Fund)
  2. Mid Cap Stock
  3. Small Cap Stock
  4. International Stock
  5. Investment Bonds
  6. Conservative Bonds

I am not affiliated with Fidelity, so I won’t get paid if you sign up. But, I’m super happy with the way the RoboAdvisor works and how inexpensive it is, so I am happy to recommend it.

But, even if you don’t use Fidelity, the important thing is that you find a low-cost way to invest in the S&P 500. Fees are not your friend.


A 1% Fee Can Cost You Half of Your Money

We have all heard the magic of compounding. It should not be terribly surprising that investing over almost 8 decades has the potential to provide massive returns.

But, it is what Warren Buffett says next that is really important.

If that hypothetical institution had paid only 1% of assets annually to various “helpers,” such as investment managers and consultants, its gain would have been cut in halfWarren Buffett, Letter to Shareholders, 2/23/2019

Low cost index funds are a relatively new entrant to the investing world. In the past, if you wanted diversification, you had to buy actively managed mutual funds. Basically, you handed your money to a team of professionals who built a portfolio of stocks and bonds and tried to beat the market.

Actively managed mutual funds charge fees in exchange for “expert management”. Those fees can be lower or higher, but somewhere around 1% is pretty common.

I double-checked the math, and I am not at all surprised that Warren Buffett is correct.

If an investor receives 11.2% average annual returns for 77 years, their money will increase by a factor of 5,288 to 1. But, if they only receive 10.2%, then their increase will only be 2,465 to 1.

Assuming that actively managed funds can match their index, then a 1% management fee can cost you half your money in the long term.

And, it gets worse.


Fund Managers Underperform Their Index

It turns out that the S&P has been tracking whether fund managers have been beating their indexes. If a fund manager can beat the index by at least 1% then you would be better off having the fund manager, right?

Well, the results are overwhelmingly bad… fund managers do not consistently beat their indexes. In fact, it is very rare for a large cap fund manager to beat their index in the long run.

Large Cap Mutual Funds Performance vs S&P 500 Index through 06/30/2020

In the 12 months ending 6/30/2020, the S&P 500 did better than 63% of actively managed large-cap funds. That means only about 1 in 3 fund managers beat the index that year.

But, that’s just the tip of the iceberg.

You should be investing for the long term. Therefore, we should look at long-term numbers. Sure, an investment manager may get beaten by the market one year, but maybe they do better over a longer time frame, right?

Wrong.

If you stretch back five years, the S&P 500 beat 78% of large cap fund managers. That means only 1 in 5 fund managers has been able to beat the market for five years.

Why would you pay extra for a service that historically has done worse than the free alternative?

Just buy low-cost index funds.


What Not to Invest In

Knowing what to invest in is only half the battle. Equally important is knowing what not to invest in.

I have exactly six investments. And, they are rebalanced regularly by the FidelityGo algorithm.

This system works for me, but you may prefer something different. And, that’s okay! As long as you follow a few simple rules.

The first rule is to only invest in things you fully understand. That means never place too much trust in your investment advisor.

The second rule is to make sure that you are actually buying investments. For me, there are three criteria that make something an investment:

  • An investment pays you for owning it.
  • An investment creates value.
  • An investment predictably responds to market conditions.

As a result, gold and other collectibles are not investments.

For the same reasons, crypto-currencies are not investments either.

When to Invest in the S&P 500

Investing is a great idea. You should definitely do it. But, you have to make sure you are ready to be an investor for the long term.

The stock market fluctuates. Over the long term, the trend has always been up. But, short-term hiccups can cause significant volatility.

I’m old enough to remember February and March of 2020, when a global pandemic knocked tens-of-millions of Americans out of work and simultaneously demolished about a third of the value of the stock market in a matter of weeks.

Before you start investing, you need to make sure that your financial house is in order. That’s why I use the 12-step plan to eliminate debt and build wealth. The first opportunity to invest is on Step 6 if you have an employer-sponsored retirement plan with a match. If not, then self-directed investing starts on Step 9.

The point is to make sure that you don’t have to liquidate your investments when something unexpected comes up. The reality is that something unexpected will always come up. So, you need to have an emergency fund set aside and your high-interest debt paid off before you start investing.


Final Thoughts

The path to eliminate debt and build wealth has a lot of forks in the road. When you decide to take control of your money, that means you will have a lot more decisions to make as you go along.

There are so many investment options available that it is easy to be overwhelmed.

The S&P 500 is simply an index that tracks the 500 largest and most successful companies in the US. The list is updated all the time so that each company is weighted based on their size. New companies are added as they grow and old companies are removed as they fall from grace.

The brilliance of investing in the S&P 500 was summed up perfectly by Warren Buffett when he said that you don’t have to know accounting or pick the right stock. You just have to bet on America.

And, that has turned out to be a pretty good bet.

What to Read Next

For more information, check out these articles that offer more detail about these topics. Enjoy!


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