The S&P 500 soared to record highs this year and confirmed its presence in a bull market — and the momentum continues, with the index heading for a 24% annual gain. Investors have gotten excited about the potential of artificial intelligence (AI) and piled into stocks in the field, and they’ve become more optimistic about the economy as the Federal Reserve launched interest rate cuts this fall.
All of this sounds great, but such gains have left some stocks trading at lofty valuations, making the general market look expensive. At the same time, any uncertainties about policies ahead in the new presidential administration could weigh on appetite for stocks as investors consider which companies may thrive and which ones may face headwinds.
These elements might make you think twice before investing in stocks right now. But before you decide to walk away from the market, listen to this advice from investing giant Warren Buffett.
Image source: The Motley Fool.
Why Buffett’s Words are Valuable
First, though, let’s consider why Buffett’s words are so valuable. And this is thanks to his spectacular investing track record. The billionaire, at the helm of Berkshire Hathaway, has helped deliver a compounded annual increase of nearly 20% over 58 years. That’s compared to a compounded increase of about 10% for the S&P 500. He’s built his fortune by selecting quality companies in industries he knows well — and scooping them up at times when the rest of the market doesn’t recognize their value. As a result, Buffett snaps up these future winners at reasonable and even cheap levels.
Some of Buffett’s most talked-about and long-held buys are solid companies driving the economy, such as American Express and Coca-Cola. And these two in particular are ones Buffett has benefited from for both their share price performance over time and dividend payments.
But there is another investment in Buffett’s portfolio that makes an ideal pick at a time when you may worry about which individual stocks to select. In fact, Buffett strongly recommends that investors include this particular type of asset in their portfolios, because it represents a bet on strong American businesses.
“American business has done wonderfully over time and will continue to do so (though, most assuredly, in unpredictable fits and starts),” Buffett wrote in his 2013 letter to shareholders.
S&P 500 Index funds
And the best way to invest in these promising businesses is to buy shares of an S&P 500 index fund, Buffett advises, as this type of asset allows investors to diversify across these top companies and keep costs down. Buffett takes his own advice, holding shares of two index funds in his portfolio — the SPDR S&P 500 ETF Trust (SPY 0.03%) and the Vanguard S&P 500 ETF (VOO 0.04%). Buffett has owned shares of both the SPDR and Vanguard index funds since the fourth quarter of 2019.
And these investments play a key role in his estate planning, as he’s advised trustees to put most of his cash into such a fund to benefit his wife.
Though Buffett’s fund has outperformed the S&P 500 over time, this performance is due to the effort and knowledge involved in stock picking. Investing in the benchmark through an index fund is effort-free and has shown itself to be a winning investment over time. So even if you’re an experienced player like Buffett, an index fund holding could nicely complement your stock picking portfolio.
Historical trends show this
And if you’re a novice or at a moment of uncertainty about what might happen next in the market, buying an index fund can be a low-risk choice that, if history is right, should deliver over time. Since the S&P 500 launched as a 500-stock index in the late 1950s, it’s delivered a 10% annualized average return. So it’s proven itself as a solid long-term investment, making an index that tracks it an ideal asset to add to your portfolio at any time.
All of this means that today, even if you’re feeling uncertain about selecting certain stocks, picking up shares of an S&P 500 index fund could be a move you’ll thank yourself (and Warren Buffett) for a few years down the road. At the same time, it’s important to remember that even with the overall stock market looking expensive, some stocks still represent good value and have what it takes to climb over the long haul — and that makes now a great time to forget about short term trends and take a long term view whether you’re buying these Buffett-recommended index funds or a stock.
American Express is an advertising partner of Motley Fool Money. Adria Cimino has positions in American Express. The Motley Fool has positions in and recommends Berkshire Hathaway and Vanguard S&P 500 ETF. The Motley Fool has a disclosure policy.
