Despite his legendary stock-picking abilities, Warren Buffett remains a staunch supporter of index funds. He favors them over most other investing options.
The Oracle of Omaha even said he’s instructed the trustee in charge of his estate to invest 90 percent of his money into the S&P 500 for his wife after he dies, Buffett told CNBC’s Becky Quick in an exclusive interview on “Squawk Box” on Monday.
“There’s been no better bet than America,” he says.
Here’s why Buffett’s favorite investment can be a smart choice for almost anyone, especially those who are new to the market.
What index funds are
Index funds are a form of passive investing. They hold every stock in an index such as the S&P 500, which includes big-name companies such as Apple, Microsoft and Google, and they offer low turnover rates, so fees and taxes tend to be low as well.
You can think of an index fund as a basket of stocks with hundreds or thousands of different ones inside, explains Nick Holeman, a certified financial planner at Betterment.
“It’s the cheapest and easiest way to diversify your money that you’re investing,” Holeman says.
The rate of return for each index fund is determined by the performance of the companies that are in it, which can balance each other out. Say you buy an index that contains only two companies, and one goes up by 3 percent but the other goes down by 2 percent. In that case, you’re still up by 1 percent overall.
Why they can be a great bet
A major benefit of index funds is that they’re low-cost. That’s because they don’t require much effort to manage: You just purchase the index and let it do its thing instead of following, buying and selling shares in particular companies.
Index funds are also tax efficient because they don’t require much trading. Managers are “not constantly buying and selling within that fund,” Holeman says. “Anytime that you do a lot of buying and selling, there’s the potential to cost yourself a lot in taxes.”
That can translate to more money in your pocket. Because you aren’t paying an advisor as much as you would for actively managed funds, you’re probably saving money in fees that could cut into your returns, Holeman says.
Another advantage to index funds is that they aren’t tied to the success of a single entity.
“The trick is not to pick the right company,” Buffett told CNBC’s “On The Money” in 2017. “The trick is to essentially buy all the big companies through the S&P 500 and to do it consistently.”
Remember, diversification is key. Always make sure that you’re doing your homework, and consider working with a financial professional (as long as they’re a fiduciary) to craft a investment plan that makes the most sense for you.
This article was first published by CNBC https://www.cnbc.com/2019/02/26/warren-buffett-wants-90-percent-of-his-estate-invested-in-index-funds.html?recirc=taboolainternal and is republished with its permission.