If 2020 taught us nothing else, it’s that the stock market is a wealth-building machine, despite a world of seemingly endless negative headlines. Even though the market was coming off of a terrific 2019, and in spite of a one-in-a-century global pandemic, the S&P 500 actually managed to surge 18.4% in 2020, including dividends. And just look at what it’s done over the past one, three, five, and 10-year periods!:
If you’re new to investing, congrats on getting started! The earlier you begin to invest, the more you’ll have in retirement.
That being said, it can be intimidating to begin investing, especially if you have a full-time job and don’t have lots of time to study individual companies.
Fortunately, you can reap the benefits of the broader market by investing in a low-cost index fund, which buys a diversified mix of stocks for you at next-to-nothing in fees. That’s why your New Year’s investing resolution should be to start with the aforementioned S&P 500 Index Fund (NYSEMKT:SPY).Â
Why Warren Buffett loves the S&P 500 Index fund, even though he doesn’t buy it himself
In Vanguard founder Jack Bogle’s book The Little Book of Common Sense Investing, Warren Buffet is quoted as saying, “A low-cost index fund is the most sensible equity investment for the great majority of investors. … By periodically investing in an index fund, the know-nothing investor can actually out-perform most investment professionals.” In fact, Buffett has even advised his estate to invest 90% of his wealth in an S&P 500 index fund after his death.
Sure, Buffett himself invests in individual stocks, but remember, he is one of the best investors of all time, and spends almost all waking hours studying companies and industries. In fact, most full-time investment managers don’t outperform the index, especially when management fees are taken into account.
The advantages of the S&P 500
Why does the S&P 500 index fund work so well? In a word, diversification. By buying a broad index of stocks, you will get a weighted average of the best companies in the market. You will get the outperformers, which then become larger portions of the index, as well as the underperformers, which become smaller. You will get stocks that are undervalued, and also stocks that may be riding bubbles to overvaluation.
The beauty of this is that over the long run, a broad index of the biggest and best stocks is almost certain to appreciate over time. In the 90 years between 1926 and 2017, the S&P 500 appreciated by an average of 9.8% per year. Of course, some years will be far below that, and others far above that, but over the long-term, it is hard to find a better wealth-compounding machine for your hard-earned savings.
Why the S&P 500 over other indexes and etfs?
If this had been another year, I might have recommended beginners opt for a more sector-specific exchange-traded fund or index weighted slightly more toward the technology sector, such as the Invesco QQQ Trust (NASDAQ:QQQ). That particular index fund aims to mimic the more tech-focused Nasdaq 100. The thinking there is that that as the world becomes more and more tech-dependent, technology stocks will gobble up an increasing portion of the economic pie.
That has not only happened, but the COVID-19 pandemic has actually accelerated tech adoption, fueled by the need for work, shop, educate, and diagnose-from-home trends. As you can see, as good as 2020 was for the S&P 500, it was even better for the QQQ, up a stunning 48.6%:
However, after tech’s epic run, many tech stocks currently sport very high valuations indeed. With vaccine distribution on the horizon for 2021 coupled with massive stimulus from the government and Federal Reserve, I think a broader swath of sectors will outperform in 2021. A boost in GDP would not only help tech, but also consumer discretionary stocks, cyclical stocks, and industrials and materials stocks. If economic growth picks up, the long end of the yield curve could increase, benefiting financial stocks.
All of these sectors are valued far below technology stocks today, which means there could be a reversion to the mean in the near-term. Of course, by buying an S&P 500 index, you still getting a healthy dose of the technology sector tech, with the large FAMANG stocks still occupying the largest proportions of the index, and the tech sector at large still occupying about 24% in total.
Of course, given the QQQ’s outperformance over the short and long-term, I wouldn’t criticize some for throwing their lot in with the QQQ today — especially if you are under 30 and have many years to go until retirement.
Still, with a broader-based economic snap-back more likely as we come out of COVID, and with tech stocks trading at very high valuations, the plain old vanilla S&P 500 index looks like the best bet for new investors today.