One of my favorite people to learn from, inside the financial world and even outside of it, is Warren Buffett. I have been a big fan of his for a long time, and even went to his annual conference with my Dad in 2017. And I tend to agree with him most of the time. But he offers some investment advice on a regular basis that I can’t quite get behind.
Before we discuss that, if you don’t know, Warren has a company called Berkshire Hathaway, which he uses to buy businesses outright, or he buys parts of businesses through the stock market. And over the last 60 years of him doing this, Berkshire has earned a 20.1% rate of return, compared to the S&P 500 return of 10.5%.
Needless to say, those results are quite impressive! And, not everyone can do that. In fact, most people can’t. Warren knows that himself, as he’s seen countless people try (and fail) to do what he does.
Which is why Warren has said for years, “In my view, for most people, the best thing to do is to own the S&P 500 index fund.”
Now I do think this is good advice, but it’s not what I do personally and it’s not what I recommend my clients do. And I don’t think you should do it either.
Before I tell you what I think you should do, I should say that I 100% agree with Warren in investing in index funds that are low cost and well diversified. We agree on that completely.
But there are three reasons why I don’t love this advice to only buy an S&P 500 index fund, despite my admiration for Warren. Let’s dive into them.
- You Should Own More Than 500 Companies: The S&P 500, as the name suggest, only invests in 500 companies. Now I do want to say that owning 500 companies is not bad at all. Too often, I see and hear of some people who think diversification is owning 10 or 20 stocks – which is crazy to me. So if you have at least 500 stocks, I do think you’re on your way to diversifying your portfolio.
However, for my own portfolio and my clients portfolios, we have over 9,000 stock holdings. Yes, the 500 companies in the S&P 500 are great, but you’re only investing in the largest companies inside the US, and I want to be invested in more companies than just those 500, to get the full benefits of diversification. So that’s my first point of disagreement with Warren. - You Should Invest Internationally as well as inside the U.S: The S&P 500 is only invested in companies inside the United States. The US has been an incredible place to invest, with our great economic system and political stability. So I absolutely want you to be invested in the US.
But, there have been numerous periods of time in stock market history when international stocks outperformed US stocks.
If you look from 2000 to 2010, the S&P 500 was essentially flat throughout that time period, due to the tech recession and Sept 11th in the early 2000s, and then the Great Recession in 2008 and 2009. During that same time period, international stocks had a solid return over the decade, and they clearly outperformed US stocks.
Since 2010, however, US stocks have massively outperformed international stocks.
What will happen the next 10 years? Or the next 30-40 years (which is the time horizon that many folks will have in retirement)? I have no clue. But at some point international stocks will have a period in which they outperform US stocks, and you simply won’t be able to capitalize on that if you are only invested in the S&P 500. - You Should Own Large, Medium, and Small Sized Companies: My third and last disagreement with Warren is that the S&P 500 only invests in large sized companies. It’s the largest 500 companies in the US. When you do that, you’re missing out on small and medium size companies which offer up great long term returns on their own.
Now to be clear, medium and small sized companies are more volatile than large sized companies, so you need to factor that into your investment plan. But if you ignore them completely, you’ll be missing out on some extra returns, as well as diversification, that you can get by incorporating them.
So there you have it, three reasons why I don’t love Warren Buffett’s advice to only buy the S&P 500. Yes, I think the S&P 500 has great companies, and I own all of those companies in my personal accounts, but I also own medium size companies, small sized companies, as well as international companies.
In short, doing that gives me more diversification, more opportunities for strategic selling and/or rebalancing, and the potential (no guarantee) of higher returns.
I hope this is helpful and if you’d like me to review your investments, as well as create a one page retirement plan for you, feel free to book a call with me at StartMyRetirement.US. Have a great week!