Exchange-traded funds (ETF) are a fairly new class of investment instruments that provide instant diversification for investors. There are two basic types of ETFs: ones that track an index, and ones that are actively managed. The second type typically gives exposure to a trend or category, like artificial intelligence or fintech. Index-based ETFs can also track an index that's been built to follow a trend, like the Vanguard Information Technology ETF.
But believe it or not, a simple S&P 500 index ETF is still one of the best investments on the market, and the Vanguard version, the Vanguard S&P 500 ETF (VOO -1.04%) is a no-brainer ETF to buy if you have $1,000 available for investment. Here's why.
The Warren Buffett way
Investing at least some of your money in an ETF that tracks the S&P 500 is a great way to benefit from market gains with low risk. The S&P 500 has on average gained 13.7% annually over the past 10 years, a steady and strong performance.
Parking some of your funds in this kind of investment is a simple way to gain exposure to 500 of the leading U.S. companies at any given time. And because such an ETF tracks an index, you don't have to fret over which companies to include; that's taken care of.
Investing legend Warren Buffett counsels every investor to invest in an ETF that mirrors the S&P 500, and Berkshire Hathaway owns two of them in its equity portfolio.
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Now, I wouldn't try to convince you not to buy single stocks at all. I think with the right mindset and approach, many individual investors do have a chance to beat the market. The statistics about money managers not beating the market are true, but they miss some important factors in the individual investor's favor. Specifically, money managers have corporate goals to reach that could hamper their creativity and how they invest. The individual investor has more freedom to pick almost any stock on the market that fits their personal investing goals.
However, that approach is riskier than investing in the broader market. The ideal individual portfolio has around 25 to 30 stocks, and that's by definition limiting. Investing in 500 stocks, and the best U.S. ones at that, gives you much greater diversification while minimizing your risk.
Better than you think
Investing in an ETF that tracks the S&P 500 might sound boring, but it's been a proven success over many decades. Consider that the S&P 500 is up 27% in 2024 less than two weeks away from the end of the year. That's an excellent return for most investors. It won't be like that every year, but averaged over time, the index has been a solid investment.
Vanguard has more than 80 different ETFs, and since its inception in September 2010, its S&P 500 ETF has generated annualized returns of them all at 14.9%. (It's not a perfectly correlated list, since different ETFs were started at different times.) That's strong performance that doesn't require any work from the investor.
The reasons I recommend the Vanguard ETF when there are alternatives are its low expense ratio and long track record. The expense ratio, which is the fee that comes off of an investor's return, is 0.03%, vs. 0.77% for similar ETFs. And the Vanguard ETF has been around for 14 years, which gives it credibility and reliability.
Finally, while this method is an excellent way to protect your money under different conditions over time, it's even more advantageous for the retiree. Once your portfolio has grown, your investing style might change to embrace safer financial instruments.
