He's Invincible in Stock Selection, Yet Recommends You Buy the S&P 500: The Truth Behind Warren Buffett's Belief

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You may have heard of Warren Buffett, renowned for his “unbeatable stock picking,” yet he advises you to choose the S&P 500 index instead of mimicking his stock-picking approach. You can take a look at the following data:

Although Buffett’s stock-picking ability is astonishing, you can still achieve an average annualized return of 10.26% by investing in the S&P 500 index. Buffett’s philosophy not only influences the U.S. but also inspires global investors, especially during market turbulence. You will learn about the advantages of the S&P 500 index, ETF investment methods, and practical advice to help you invest rationally.

Key Points

• Buffett recommends ordinary investors choose S&P 500 index funds due to their stable long-term returns and risk diversification.
• Investing in the S&P 500 index allows you to participate in the overall growth of the U.S. economy, with an annualized return of 10.99% over the past 30 years.
• Choosing low-cost ETFs, such as VOO and IVV, can help you save on costs and is suitable for long-term holding.
• Long-term holding of high-quality assets is the key to successful investing, and avoiding frequent trading can reduce costs and risks.
• Rational investing and patient waiting are crucial strategies for wealth growth, and following Buffett’s philosophy can help you achieve higher returns.

Unbeatable Stock Picking vs. Index Investing

Buffett’s Investment Prowess

You might think Buffett’s “unbeatable stock picking” makes him a role model, as his investment track record is beyond the reach of most. Buffett’s success stems from his unique investment philosophy and strict criteria. You can understand his advantages from the following aspects:

• After studying Fisher’s theories, Buffett began buying high-quality companies’ stocks at reasonable prices. He doesn’t blindly chase popular stocks but focuses on the long-term value of businesses.
• He places great emphasis on the integrity and capability of company management. An excellent management team can deliver sustained returns to shareholders.
• Buffett pays attention to a company’s capital allocation history. He believes good capital allocation decisions are more important than flashy strategic plans.
• He prefers to invest in companies with the highest profit margins in their industries. These companies typically generate higher investment returns.
• Intrinsic value is a key tool Buffett uses to assess investment attractiveness. He excels at identifying undervalued high-quality stocks.

You will find that Buffett’s “unbeatable stock picking” is no accident. He uses rigorous methods and extensive experience to select companies truly worth holding long-term. Ordinary investors find it difficult to replicate his stock-picking process and judgment criteria.

Challenges for Ordinary Investors

While you may aspire to become an “unbeatable stock picker” like Buffett, the reality is harsh. Most people lack the expertise and time to research companies as thoroughly as Buffett does. In practice, you often encounter the following issues:

• Lacking mental preparation, you’re prone to making wrong decisions during market volatility, leading to selling at low prices and incurring permanent losses.
• You may have overly high return expectations but low risk tolerance. Many try to time the market to avoid risks, but the results are often counterproductive.
• Frequent short-term trading increases transaction costs, eroding investment returns.
• Your values and investment approach directly impact your final returns. Emotional fluctuations can easily lead to poor choices during market volatility.

Buffett understands these challenges for ordinary investors. He has repeatedly advised in public that you shouldn’t blindly mimic his “unbeatable stock picking” but instead choose a simpler, more effective approach. At a Berkshire Hathaway annual meeting, he said:

“I think for most people, owning an S&P 500 index fund is the best choice. People spend a lot of money buying stock-picking advice, but they don’t need to. If you bet on America and hold your position for decades, your returns will be far better than buying Treasuries or following stock-picking advice.”

You can see that between 1993 and 2018, Buffett recommended investing in the S&P 500 index 14 times. He also emphasized that if you lack the energy to research individual stocks, you should choose a large-scale index fund, hold it long-term, and enjoy the dividends of U.S. economic growth.

You don’t need to be an “unbeatable stock picker” to achieve solid long-term returns. Choosing an S&P 500 index fund allows you to diversify risk and skip the complex stock-picking process. This is the path of rational investing that Buffett repeatedly emphasizes.

S&P 500 Index Overview

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Index Composition

You can view the S&P 500 index as a microcosm of the U.S. economy. This index consists of 500 large U.S. companies, covering industries such as finance, information technology, healthcare, and consumer goods. You will find that these companies are not only large in scale but also highly competitive in their respective fields. The following table showcases some S&P 500 constituent companies:

You can see that the S&P 500 index includes leading companies in healthcare and technology, as well as other key industries. This broad industry coverage allows you to diversify risk while investing and benefit from the overall growth of the U.S. economy.

Economic Representation

Investing in the S&P 500 index means investing in America’s most outstanding and promising companies. This index uses a weighted average method to more accurately reflect market changes. You can understand the economic representation of the S&P 500 through the following points:

• The S&P 500 index is regarded as a representative index of the U.S. economy, with broad industry coverage.
• It spans finance, consumer staples, information technology, and other sectors, reflecting the upgrading trends of U.S. industries.
• Its compilation method is reasonable, avoiding the volatility issues of other indices.
• By investing in the S&P 500 index, you can more accurately capture the overall development trends of the U.S. economy.

Choosing the S&P 500 index means choosing the long-term growth of the U.S. economy. The index’s stability and broad coverage allow you to invest with peace of mind over the long term.

Historical Performance

Long-Term Returns

By choosing to invest in the S&P 500 index, you are participating in the long-term growth of the U.S. economy. Over the past 30 years, the S&P 500 index has achieved an annualized return of 10.99%. If you invested in the S&P 500 at the start of 1995 and held it until the end of 2024, you would see steady asset growth. Long-term holding also allows you to experience the power of compounding. For example, John Bogle’s statistics show that $1 invested in 1900 grew to $43,650 by 2015. This growth primarily comes from an annualized return of about 9.5%, including dividends and earnings growth. You don’t need to trade frequently like an unbeatable stock-picking guru; simply holding long-term allows you to benefit from the U.S. economy’s growth dividends.

Tip: The S&P 500 index typically performs well during economic expansion periods, may decline during recessions, but overall, its long-term returns remain impressive.

Risk Diversification

When you invest in the S&P 500 index, your capital is automatically allocated across 500 large companies spanning multiple industries and sectors. This diversified investment approach can effectively reduce the risks associated with a single company or industry. For example, when one industry underperforms, companies in other industries may perform well, smoothing overall returns. You can further reduce portfolio volatility by reasonably allocating low-risk assets (such as cash or bonds) and high-risk assets (such as stocks). Diversified investing not only stabilizes your returns but also helps you maintain confidence during market fluctuations. Although market volatility, industry changes, and investor sentiment can affect fund performance, in the long term, diversification and the compounding effect will lead to steady asset growth.

Investment Philosophy

Value Investing

You often hear the term “value investing” when investing. Buffett’s value investing philosophy emphasizes that you should focus on a company’s intrinsic value rather than short-term market fluctuations. You can understand his core ideas through the following aspects:

• Margin of Safety: When buying assets, you should ensure the price is below their true value to reduce risk.
• Long-Term Investing: You hold high-quality companies, leveraging the compounding effect of time to achieve steady wealth growth.
• Intrinsic Value: You assess a company’s true value by analyzing financial statements and future growth prospects.
• Exceptional Management Team: You focus on the capability and integrity of management, as they determine the company’s long-term performance.

Buffett’s “unbeatable stock picking” stems from his ability to accurately assess business value and hold long-term. If you lack the expertise and time, it’s hard to replicate his stock-picking process. By choosing index funds, you can achieve market-average returns with a simple approach, avoiding losses due to misjudgments.

Who Index Investing Suits

You may wonder, who is index investing suitable for? In fact, index funds include both exchange-traded and non-exchange-traded funds, as well as regular and enhanced types. You can choose the right product based on your trading habits and risk preferences. Index investing is particularly suitable for the following types of investors:

• You want to achieve market-average returns through a passive investment strategy.
• You don’t want to spend a lot of time researching individual stocks.
• You value low fees, risk diversification, and performance transparency.
• You want an investment process minimally influenced by human factors.

U.S. market data shows that from 1980 to 1998, only 35% of mutual funds outperformed the index. By investing in index funds, you can diversify risk and avoid the pitfalls of emotional and human biases. For example, herd mentality may lead you to chase rallies in bull markets or sell off in bear markets; overconfidence may cause you to overlook risks; and the endowment effect may affect your rational judgment of assets. Choosing index funds can reduce these behavioral biases and deliver more stable long-term returns.

Practical Operations

ETF Selection

When choosing an S&P 500 ETF, you can focus on SPY, VOO, and IVV, the three mainstream products. They all track the S&P 500 index but differ in fees and liquidity. SPY’s management fee is 0.0945%, while VOO and IVV have fees of only 0.03%. For long-term investing, low fees can save significant costs. The table below shows the management fees of these three ETFs:

SPY’s average daily trading volume is much higher than VOO and IVV, making it suitable for short-term traders. VOO and IVV are better for long-term holding. You can choose based on your investment goals and holding period. If you prioritize liquidity, SPY is a good choice. If you plan to invest long-term, the low fees of VOO and IVV are more advantageous.

Tip: Before investing, you should understand the fee structure and liquidity of ETFs and make rational choices based on your needs.

Investment Process

When investing in an S&P 500 ETF, you can follow these steps:

1. Choose a suitable ETF fund based on your investment goals and risk preferences.
2. Open a securities account with a licensed Hong Kong bank, providing identity proof and other required documents.
3. Deposit funds in USD into the securities account. You can refer to the USD to CNY exchange rate (June 2024 data).
4. On the trading platform, convert CNY to USD to prepare funds.
5. Enter the trading page, input the ETF ticker (e.g., SPY, VOO, IVV), and place a buy order.
6. Confirm whether the transaction was executed successfully.
7. Hold the ETF and periodically monitor its performance, adjusting your investment based on market conditions and personal needs.

During the long-term holding process, you should pay attention to market volatility and your risk tolerance. Avoid using leveraged ETFs, especially in volatile markets, as long-term holding may lead to significant losses. Regularly reviewing your portfolio helps you achieve steady growth.

Recommendation: You should focus on long-term holding, reduce frequent trading, and patiently wait for the compounding effect to take hold.

The Truth Behind the Belief

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Will Arrangements

You may be curious about how Buffett plans his wealth. In his will, Buffett provides very clear instructions:

“My investment instructions to the trustee are as simple as it gets: take 10% of the assets to buy short-term government bonds and invest the remaining 90% entirely in an S&P 500 index fund.”

You can see from this arrangement that Buffett has strong confidence in S&P 500 index funds. He believes that holding low-cost index funds long-term is the most stable investment approach. You don’t need complex strategies or frequent trading; simply holding long-term allows you to achieve market-average returns. Buffett’s reasoning includes:

• Buffett recommends investing 90% of his estate in a low-cost S&P 500 index fund.
• He believes most actively managed fund managers cannot outperform this benchmark.
• His will reflects his belief in long-term holding of low-cost index funds.
• Over 90% of fund managers underperform the S&P 500 index fund.
• The S&P 500 index fund offers market-average returns higher than most actively managed investments.

You can see that Buffett uses his wealth arrangements to convey his belief in rational investing.

Essence of Investing

When investing, you should focus on long-term holding and rational decision-making. Buffett’s success provides a great reference for you:

• In 1987, Buffett invested in Coca-Cola and has held it for over 30 years, weathering multiple market fluctuations, demonstrating the success of long-term holding.
• In 2016, Buffett invested in Apple, which continued to perform strongly 40 years after its founding.
• In 1989, Buffett invested in Gillette through convertible preferred stock, later successfully converting to Procter & Gamble shares.
• In 2000, Buffett first invested in Moody’s, a century-old company.
• In 1963, Buffett invested in American Express and increased his stake again in 1991.

You can observe that long-term investing yields higher returns compared to short-term trading. Compounding and time are the main drivers of return growth, and investors can enjoy the compounding effect through long-term holding. Successful investing lies in consistent investment rather than trying to perfectly time the market. As long as you stick to rational investing, choose high-quality assets, and hold them long-term, you can achieve steady wealth growth.

You can learn the value of rational investing and long-term holding from Buffett’s advice. U.S. companies collectively continue to create prosperity, and actively managed funds struggle to outperform the S&P 500 index. You should choose an appropriate asset allocation based on your investment goals and risk tolerance, avoiding frequent trading and chasing short-term gains. Holding high-quality company stocks long-term and patiently waiting for 3 to 5 years typically yields higher net returns.

Jesse Livermore once said, patience is the key to successful investing. As long as you respect the principles of investing and learn to wait, you can build confidence and achieve wealth growth.

FAQ

How Much Capital Is Needed to Invest in an S&P 500 Index Fund?

You can start investing in an S&P 500 index fund with very little capital. Many brokers allow you to buy fractional shares. You don’t need to invest a large amount at once.

Can an S&P 500 Index Fund Lose Money?

When you invest in an S&P 500 index fund, you may experience short-term losses. However, historical data shows stable returns over the long term. You need to be patient.

What’s the Difference Between ETFs and Mutual Funds?

When you buy ETFs, you can trade them like stocks during market hours. Mutual funds are typically settled at net asset value after market close. ETFs generally have lower fees and higher liquidity.

Can I Sell an S&P 500 ETF at Any Time?

You can sell an S&P 500 ETF at any time during U.S. market trading hours. Trading is highly flexible. You simply need to operate through a broker’s platform.

Do I Need to Pay Taxes on an S&P 500 Index Fund?

When investing in an S&P 500 index fund in the U.S. market, you need to pay relevant taxes on dividends and profits from sales. You should understand tax regulations in advance.

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