Why Warren Buffett recommends ETF while he himself doesn’t invest in individual stocks?

Warren Buffett has recommended low-cost index fund (perhaps the most popular security for passive investing) more than once.

It intrigues me — why the most successful investor in the world recommends ETF and passive investing while he himself doesn’t invest in ETF?

For those of you wondering:

Passive investing = you find a security and you buy and hold forever to reap the compounding benefit

Active investing = you constantly find new security to replace old one, buy and sell regularly, in the hope to outperform the market

After some thoughts, I found out the underlying reasons why Warren Buffett recommended low-cost ETF:

In 2021 annual Berkshire Hathaway meeting, Warren Buffett shared a list of 20 stocks with the largest market capitalization as of March, which included Apple, Amazon, Alphabet, Microsoft, and Facebook etc. He asked the audience which of those stocks they predict would remain in 30 years.

No one can answer that of course.

Buffett then shared the top 20 companies by market capitalization as of 1989, among them some Japanese companies, Exxon, General Electric and IBM. He asked the audience which of those stocks they think have remained in 30 years.

The answer: none of those remain in the top 20 today.

“I would guess that very few of you would have said zero, and I don’t think it will be, but it’s a reminder of what extraordinary things can happen…..We were just as sure of ourselves, and Wall Street was, in 1989 as we are today. But the world can change in very, very dramatic ways. After all, a lot more to picking stocks than figuring out what’s going to be a wonderful industry in the future.” Buffett said.

This — coming from a successful investor like Warren Buffett really hits me hard and made me think –

(1) if none of the TOP 20 companies can stay on the list for more than 30 years, why should I invest now because the companies are going to fall and I’m going to lose money eventually. How can I protect my money and still achieve reasonable return in the long term?

(2) It’s really difficult to bet on any one (or any twenty) of companies who can make it in the next 10, 20, or 30 years. Stock-picking is not an art nor science, it is real gambling.

Buffett built his wealth based on stock analysing and then buy and hold for 30 years or more. And now he is telling us that it is hard to analyse the stocks because even “good” companies disappear in the long run. In fact, in recent years, we have seen Buffett making more mistakes on investing in companies that lead to losses. Here’s the truth: stock-picking is hard.

Buffett may have the same reflection himself as well. He then offered his answer:

”There were at least 2,000 companies that entered the auto business because it clearly had this incredible future……And in 2009, there were three left, two of which went bankrupt……It’s a great argument for index funds. If you just had a diversified group of equities, U.S. equities, that would be my preference, but to hold over a 30 year period.” Buffett said.

There, he offered his solution to the problem he pointed out.

And the solution is to have a diversified group of equities and hold over a 30-year period. Obviously, Buffett still believes in the power of compounding. He himself is arguably the biggest benefit from the compounding rule. His investment strategy to hold securities for extremely long period has proven to reward him with fruits sweeter than other impatient investors. So, Buffett still wants us to make use of this magical power of compounding and hold long term. And he suggests that instead of individual stocks, we hold a diversified group of securities.

He went on to share more on exactly what he would invest. Buffett he has instructed the trustee in charge of his estate to invest 90% of his money into the S&P 500, and 10% in treasury bills, for his wife after he dies. “I just think that the best thing to do is buy 90% in S&P 500 index fund.”

Whether S&P 500 index fund is the right security for everyone is not our concern now, because that will take more than 100,000 words to dive into the different types of ETFs that we can choose from and comparing which one would be the best for our financial goals. If you are interested to dive in to learn more, there is a passive investing course for busy professionals that make it easy and systematic to learn about low-cost funds and create your investment portfolio in as fast as 7 days.

We can see Buffett’s proposed solution to stock picking: when we hold a diversified group of equities, we don’t need to bet on any particular companies, and the fund will automatically replace new companies when the old ones fades for continuity.

Does Buffett’s proposed solution work?

I have tested it out personally with my own investment portfolio. Although I do not follow exactly the choice of securities and the proportion because everyone’s financial situation is different. What works for Buffett in his case may not be the best for us. I do have S&P 500 index fund in my portfolio but the proportion is less than Buffett’s one.

The result?

The portfolio has grown to 6 figure now and it’s getting an average return of 6–7% compounded annually. I should also mention that I only take 5 minutes or less each month on it and I sleep very well at night even when the market falls.

Do you want to learn how to choose ETFs and apply Buffett’s proposal to create your own low-cost fund portfolio too?



Writes about Career acceleration; FIRE Retire in 10 years; Passive investment; Abundant mindset

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Connie C

Writes about Career acceleration; FIRE Retire in 10 years; Passive investment; Abundant mindset