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Warren Buffett is one of the best investors in history, and his company, Berkshire Hathaway, has outperformed the S&P 500 over the last 50+ years. Known as the Oracle of Omaha, Buffett has touted the strength of index funds for the average investor. But does Warren Buffett only invest in index funds?
Warren Buffett does not only invest in index funds. In his fund at Berkshire Hathaway, Buffett does own two S&P 500 index funds (VOO and SPY), but they make up a very small portion of his portfolio. For the majority of investors however, Buffett recommends index fund investing.
Find out what Warren Buffett invests in, and why he recommends index fund investing for the average investor.
What Does Warren Buffett Invest In?
Warren Buffett’s portfolio at Berkshire Hathaway primarily invests in large, blue-chip companies.
Buffett is a master value investor, which is investment strategy where you buy a company you deem to be undervalued, then hold them over a longer time-frame (5+ years) as it reaches a more accurate valuation. Buffett looks for strong value sheets and attractive valuations. He typically invests for the long-term, but will make new investments or drop long-time holdings if necessary.
As of this writing, the top holdings in Buffetts portfolio are:
- Apple (AAPL) – Apple makes up about half of Buffett’s portfolio. Buffett did most of his acquisition of Apple between 2016 and 2019.
- Bank of America (BAC) – Bank of America makes up ~8.5% of Buffett’s portfolio
- American Express (AXP) – Buffett owns about 20% of American Express’s outstanding shares, making up ~7.5% of his portfolio
- Coca-Cola (KO) – Buffett famously drinks a lot of Coke, so it’s not surpising Coca-Cola makes up almost 7% of his portfolio
- Chevron (CVX) – Buffett cut his holdings of Chevron in half in the first half of 2023, but it still makes up more than 5% of his portfolio
Buffett does hold two S&P 500 index funds in his portfolio (SPY & VOO), but they make up less than 0.1% each.
What Index Fund Does Warren Buffet Recommend?
In his 2013 Berkshire Hathaway letter to investors, Buffett recommends “a low-cost S&P 500 index fund” for non-professional investors. He does not specify in the letter which fund to choose, but in his portfolio he holds SPY & VOO, though in very small quantities.
The SPDR S&P 500 ETF Trust (SPY) is an index fund that aims to replicate the S&P 500. This fund is issued by State Street Global Advisors, which offer a variety of low-cost index funds. This fund specifically has a Gross Expense Ratio of 0.0945%, meaning that for every $10,000 invested, you will pay $9.45 in fees annually. This is significantly lower than comparable mutual funds.
The Vanguard S&P 500 ETF (VOO) is issued by Vanguard. Similar to SPY, it follows the S&P 500. It’s expense ratio is 0.03%, which corresponds to $3 per $10,000 invested – even less than SPY.
Regardless of which index fund you choose, make sure you review the expense ratio and confirm the holding are what you expect.
Why Does Warren Buffett Recommend Index Funds?
Though Warren Buffett does own a lot of index funds, he does recommend them for the average investor.
In 2020, he said:
“In my view, for most people, the best thing to do is to own the S&P 500 index fund. People will try and sell you other things because there’s more money in it for them if they do.”
Warren Buffett – Berkshire Hathaway Annual Shareholder Meeting 2020
Beating the market (i.e. obtaining better returns than the S&P 500) is really difficult. In fact, over the last 10 years, more than 90% of large-cap funds underperformed the S&P 500. And this is professional fund managers, with a team of people around them to help. There are a few exceptional fund managers out there (Warren Buffett being one of them), but being able to consistently outperform the market is very rare.
Most people won’t be able to achieve returns that exceed the S&P 500, and by actively trading, fees can cut down your returns even more. In 2014, Buffett said:
“Investors, of course, can, by their own behavior, make stock ownership highly risky. And many do. Active trading, attempts to ‘time’ market movements, inadequate diversification, the payment of high and unnecessary fees to managers and advisors, and the use of borrowed money can destroy the decent returns that a life-long owner of equities would otherwise enjoy.”
“The commission of the investment sins listed above is not limited to ‘the little guy.’ Huge institutional investors, viewed as a group, have long underperformed the unsophisticated index-fund investor who simply sits tight for decades. A major reason has been fees: Many institutions pay substantial sums to consultants who, in turn, recommend high-fee managers. And that is a fool’s game.”
Warren Buffett – Berkshire Hathaway shareholder letter 2014.
Beating the market is possible (as Buffett has shown), but incredibly hard. So most investors are better off just purchasing index funds.
How Well Have Index Funds Performed?
Historically, the S&P 500 has returned about 10% annually.
This means that if you invested $10,000, and left it for 15 years, it would be worth $43,635. If you had invested that same amount with an active fund, there’s a 93% chance that your investment would have underperformed. Those are not odds I would take.
Though it is possible to beat the S&P, the people that can do it consistently are few and far between. Index fund investing is a great way to get strong growth while putting your time and energy elsewhere.
What are the Pros and Cons of Index Funds?
Here is the pros and cons of index fund investing:
| Pros | Cons |
| Very low effort, able to invest time and energy elsewhere | Low excitement, no active involvement in the growth of your investment |
| Returns will match the market returns, and will not underperform | Investment will never outperform the market |
| Low-cost, very low management and trading fees | Little downside protection during market downturns |
| Simple, no need to keep up with portfolio or research stocks | No intellectual challenge with investing |
| Easy diversification | Limited control over stocks held |
Why Index Funds Often Outperform Active Investing Strategies
Index funds often outperform active investing strategies due to the fees associated with active trading.
Index funds have very low management expense ratios (MER), charging less than $10 per $10,000 investing. This is because the holdings mimic the index, so there is no research or active management required by the fund. They are also buy-and-hold, so the trading expenses are minimized.
Active strategies however require teams to do research, increasing the management costs. The portfolio manager also needs to be diligent and is constantly adjusting the portfolio. These two things result in much higher fees, sometimes resulting in more than $200 per $10,000 invested.
For an active investment to outperform index funds, it needs to outperform both the index and the fees. Let’s imagine you’re paying an active manager (whether a fund or a financial advisor) 2% in fees anually. So if the index fund returns 10%, for your investment to beat the index, the active strategy needs to return 10% + 2% fees for a total of 12%. That is a significant improvement over the market, and is really difficult to do.
It can be done, but the odds active management outperforms index funds over the long term is low.
Round-Up
Index funds are a great, easy way to grow your money. Take it from investing legend himself:
“A low-cost index fund is the most sensible equity investment for the great majority of investors.”
Warren Buffett – The Little Book of Common Sense Investing
Learn more about index funds, and see if they’re right for you.