The Average Investor Can’t Beat This Index Fund
Americans hear a lot of questionable hot takes from senior citizens. That’s largely why this year’s presidential candidates are historically unpopular.
Politics aside:
- The incumbent was born in 1942, when Anne Frank received a blank diary and baseball teams first played night games.
- His opponent was born in 1946, when Tupperware was invented and the first electronic computer was created.
Regardless of who wins, either one will be leading America into their 80s rather than enjoying an overdue retirement, which is worrisome because, when it comes to politics, older candidates are often out of touch with pressing issues.
However, in other arenas, the wisdom of older generations should be treasured. That’s precisely the case with one nonagenarian whose time-tested advice has been rewarding adherents for decades.
The Oracle of Omaha
Since 93-year-old Warren Buffett purchased his first stock at age 11 in 1941, the markets have mostly operated the same. Understanding that has allowed Buffett to amass a fortune by finding stocks of great companies at undervalued prices.
This has resulted in a catalog of Buffett-isms, including:
“Should you find yourself in a chronically leaking boat, energy devoted to changing vessels is likely to be more productive than energy devoted to patching leaks.”
And …
“When it rains gold, put out the bucket, not the thimble.”
But for most people who find themselves in a leaking investment or a downpour of gold, choosing which stocks to buy and sell is no simple task.
One solution: Buying an exchange-traded fund (ETF) that gives you exposure to the best stocks at a fraction of their share prices. And if you pick the right one, year in and year out, you’ll be doing better than most.
Don’t take our word for it, though. Take Buffett’s:
“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.”
S&P 500 Index Funds
The idea behind passively-managed index funds is that they aim to provide similar returns as an underlying benchmark.
Buffett’s a proponent of funds tracking the S&P 500, of which there are several offered by Fidelity, Vanguard, Schwab, Invesco and State Street.
If you drill down into each fund’s holdings, they’re mostly the same. That’s because they attempt to mirror the performance of the best companies in the S&P 500.
That’s why you’ll see the following behemoths in almost all of them:
For passive investors, an index fund means spreads their dollars among the companies composing that index, with weightings sending the bulk of their investment towards the biggest and best performers.
That’s why, since its inception in 1993, the SPDR S&P 500 ETF Trust (SPY) has been so popular. In fact, the SPY’s creation is credited with the advent of the ETF era.
Over the past 30 years, it posted a return of 1,030.54% following the benchmark S&P 500 index, which returned 1,040.89% over the same period.
When you see numbers like that, Buffett’s advice makes sense. These ETFs provide broad exposure and don’t require rebalancing on the part of the shareholder as index funds are periodically rebalanced to reflect any changes in the benchmark.
The result is a robust, historical average annual return of 10.25% for the SPY. But that dates back to its inception since 1957.
For the past six years — including the short-lived COVID recession in 2020 and 2022’s nearly year-long bear market — the S&P has returned 13.73% annually.
So it’s understandable why the SPY is a favorite among passive investors. However, there’s a way to get …
The Same Exposure at a Much Lower Cost
The SPDR Portfolio S&P 500 ETF (SPLG) is a lesser-known index fund. It debuted in 2005, which is why its assets under management are $28.34 billion versus the SPY’s $494 billion.
However, at 0.02%, the SPLG has an expense ratio that’s 77% lower than the SPY’s 0.09%. That means for every $1,000 you invest into SPLG, you pay $20/year in management fees vs. $90/year for the same amount in the SPY.
Meanwhile, the top holdings for each fund are identical, with infinitesimal differences in the weightings of those positions:
The result? Indistinguishable performance, as shown in the following five-year chart:
SPLG also offers the stronger dividend compared to the SPY, with the former yielding 1.38% and the latter yielding 1.34%.
Icing the cake: Share price. Here, again, SPLG has the edge.
Not every brokerage offers fractional shares, meaning the SPY isn’t an option for the average retail investor. At the time of writing, the SPY’s trading for $496.76. Meanwhile, the SPLG’s trading for $58.42 … or 88.24% less for nearly identical performance.
Recap
If you don’t trust yourself with choosing individual stocks, don’t. Investing in an S&P 500 index fund is a great way to pace the market, which will provide strong average annual returns.
While our presidential options in 2024 are horrifying, you could do a lot worse than taking the advice of an old timer like Warren Buffett.