Key Points
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Now more than ever, it’s crucial to invest in quality long-term stocks and funds.
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The S&P 500 ETF is a powerhouse investment endorsed by Warren Buffett.
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However, there are two key drawbacks to consider before you buy.
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The S&P 500 (SNPINDEX: ^GSPC) is up by more than 10% over the last three months alone, as of this writing — its most successful quarter in years. But it’s also a historically expensive time to invest, and some metrics are sounding the alarm over the market’s valuation.
For example, the Buffett indicator — named for Warren Buffett after he used the metric to predict the dot-com bubble burst — now sits at a record high of 236%. In a 2001 interview with Fortune Magazine, Buffett himself noted that when this metric nears 200%, investors are “playing with fire.”
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Now, this doesn’t necessarily mean that a bear market or recession is around the corner. But it’s more important than ever to ensure you’re investing in strong long-term stocks and funds. There’s one investment Buffett has strongly recommended for decades, and history proves he’s been right every single time.
Image source: The Motley Fool.
A failsafe long-term investment
For decades, Warren Buffett has recommended the S&P 500 ETF. During Berkshire Hathaway‘s 2020 meeting, he even went so far as to call it “the best thing” for most investors.
In 2008, he also made a $1 million bet that this type of investment could outperform a group of actively managed funds. After 10 years, his S&P 500 fund had earned total returns of nearly 126%, while the five actively managed funds averaged a total return of around 36%.
History backs up Buffett’s approval of the S&P 500 ETF, too. Analysts at Crestmont Research studied the S&P 500’s long-term performance and found that since the index’s inception, it’s ended every 20-year period with positive total returns regardless of how volatile the market was during that period.
In other words, by holding an S&P 500 ETF for at least 20 years, it’s historically been harder to lose money with this investment than it is to make money.
Two risks to consider before buying
One potential downside to the S&P 500 ETF is that it’s becoming increasingly dominated by tech stocks, making it more vulnerable to volatility.
For example, the “Magnificent Seven” — which includes Apple, Amazon, Alphabet, Meta Platforms, Microsoft, Nvidia, and Tesla — make up around one-third of the S&P 500’s total value, making the S&P 500 ETF more easily swayed by megacap tech companies. If those stocks are thriving, it can lift the S&P 500 to new heights. But if they falter, they can drag the entire index down with them.
With a long enough timeline, this may not be an issue for many investors, as most leading companies can recover from downturns and achieve long-term growth. But it can result in more short-term volatility than some investors expect, so it’s an important factor to consider.
The other potential downside is that because the S&P 500 ETF tracks a major market index, it’s impossible for it to beat the market. Over time, even a seemingly minor difference in performance can add up.
Let’s say you’re investing $200 per month in an S&P 500 ETF earning a 10% average annual return — which is in line with the S&P 500’s historic average. Let’s also say that you could invest $200 per month in a growth ETF earning a marginally higher 11% average annual return. Over decades, here’s approximately how much you could earn in total with each investment:
| Number of Years | Total Portfolio Value: 10% Avg. Annual Return | Total Portfolio Value: 11% Avg. Annual Return |
|---|---|---|
| 20 | $137,000 | $154,000 |
| 25 | $236,000 | $275,000 |
| 30 | $395,000 | $478,000 |
| 35 | $650,000 | $820,000 |
| 40 | $1,062,000 | $1,396,000 |
Data source: Author’s calculations via investor.gov.
No investment is perfect, and the S&P 500 ETF won’t be the ideal fit for everyone, especially investors nervous about the tech industry’s volatility or looking to maximize their earnings in the stock market.
However, there’s good reason why Warren Buffett highly recommends the S&P 500 ETF. It shines with its consistency over decades, and even while earning average returns, it’s still possible to accumulate hundreds of thousands of dollars with this investment.
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Katie Brockman has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Alphabet, Amazon, Apple, Berkshire Hathaway, Meta Platforms, Microsoft, Nvidia, and Tesla. The Motley Fool has a disclosure policy.
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