Warren buffett favors Index fund! Why?
It might be shocking news for the wall street analyst, Hedge fund managers, active fund managers, and all other adherent followers of Mr. Buffett, when Buffett favors index fund
Buffett confidence on index funds went to the extent of betting against active fund managers / hedge fund managers to beat the index on a period of ten years for one million dollar bet. At the end , Buffett won the bet when an index fund massively outperformed performed than the hedge funds.
Not only that, Buffett is a man who walks the talk, he holds 13.4 million on Vanguard index ETF in his Berkshire Hathaway portfolio.
He has also given instructions to the trust fund after he is gone, 90 percent of his wealth should be moved to the index fund and 10 percent should be held as cash for his wife.
why Buffett favors Index funds: 3 reasons
- A low cost fund
- Ever changing business
What is an Index fund?
An Index fund is an ETF or mutual fund tracks the market index which represents the top fifty, hundred or five hundred companies of a country or a particular sector by their market capitalization. since investors can not directly invest in market index, Index fund offers indirect investment option to investors by tracking the market index.
What consists of Index fund?
Index fund is a basket of securities or shared which are selected on the basis of market capitalization (market cap). So the companies with large market capitalization will placed in Index fund. The larger the market cap, higher the weightage is given in an index fund.
Market cap is calculated by multiplying the share price of a company with the number of shares outstanding.
Lets look at the reasons briefly why the “Oracle of Omaha” Warren buffett favors the index fund
Low cost fund:
Investing in index fund is known as “passive investing”. In this the fund is passively managed by the fund manager who mimics the market index. Due to this factor, he doesn’t need to study, research and pick individual securities to beat the market index. Because of this underlying reason, the index fund carries very low expense fee.
When a fund has low expense fees and provides market average returns to its investors , obviously its an great way to maximize & grow wealth for long term investors. Buffett pays for value , not for cheap. When an index funds offers these favorable odds to every investors, why Buffett doesn’t preach about index fund to the investing world.
More over the active fund managers are getting paid to beat the market indices, so higher expense ratio because of their active involvement in buying & selling the securities to achieve higher alpha.
Also more than 90 percentage of active funds fails to beat the index fund return on a 10 year period.
Being 90 percent right than 10 percent wrong is a smart choice isn’t? 🙂
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Ever changing business:
Index fund is occupied by the largest market cap companies. In 1990’s, the list of companies occupied in the index fund is not appeared after two decades. Due to growth & changing in business dynamics the index fund is occupied by new entrants like digital business, platform based businesses.
List of companies in index fund at 1990 ,2010,2020 varies from time to time. The reason is value chain migration from manufacturing companies, finance firms to internet based firms, Platform providers like Amazon, Google etc.
When you invest in an index fund it rebalances itself as per the large market capitalization.
You no need to come from an accounting or finance background, you need to analyze the balance sheet of a individual company, you do not need to follow the quarterly, half yearly results of a firm, no need of IQ more than 160, no requirement of degree from Ivy league business schools.
You do not need to be a wizard, edge in a particular industry of stock market. This is one of the important reason why Buffett preaches index fund to an average investor. Active fund managers underperform index fund is an inevitable event as the market matures.
There is no eligibility criteria to invest in an index fund except for this rule! All you need is to save ,appreciate long term investing & compounding. If you follow it like the bible, you would have done considerably well for yourself. Thank me later!