The ONLY Fund Buffett Recommends (hint, it’s not his own)

As probably the world’s best-regarded stock picker, Warren Buffett isn’t usually associated with ETFs. Nevertheless, the legendary value investor’s portfolio at Berkshire Hathaway contains two ETFs, both of which track the S&P 500 index.

These two funds, namely SPY and VOO, account for a little over $45 billion of Berkshire’s total holdings. Why does Buffett own the S&P 500, and what is the role of these funds within the Berkshire Hathaway portfolio?

Key Points

• Berkshire holds over $45 billion in SPY and VOO, its second-largest stock position after Apple, added in late 2019.
• Buffett favors the S&P 500 for its reliable long-term returns, low costs, and dividends, recommending it over costly active funds.
• The ETFs allow Buffett to deploy capital efficiently in a challenging market, offering broad exposure without relying on individual stock picks.

When Did Buffett Buy the S&P 500?

Buffett’s ETF holdings in the S&P 500 are surprisingly new, dating back only to Q4 of 2019. While many of Berkshire’s positions were trimmed or adjusted during the unusual 2020-21 era, these funds have remained a foundation of the investment company’s portfolio.

While Berkshire Hathaway hasn’t owned the S&P 500 for very long, Buffett has a long history of recommending index funds as the best investment solution for most investors.

At the 2021 Berkshire annual meeting, Buffett specifically recommended the index for most investors, despite saying that he had never recommended even Berkshire to anyone. Buffett’s faith in the index runs so deep that he has even left instructions for his estate to invest 90% of his remaining wealth into S&P 500 funds for his wife.

At one point, Buffett famously even went so far as to wager against fund managers’ abilities to beat the index. In 2008, he placed a $1 million bet with hedge fund Protege Partners on the basis that the S&P would outperform a group of five active funds selected by Protege over a 10-year period.

Buffett won hands-down, showing that his bullishness on the index could be backed up even against the performance of some of the best investment minds on Wall Street.

Why Buffett Loves the S&P

As one of the few investors ever to have successfully outperformed the S&P 500 over long periods of time, it may seem strange that Buffett is such a fan of the index. His reasoning, however, is based on a simple observation that the S&P 500 offers superior long-term returns that track with the growth of the American economy. Over the last century, the S&P and its preceding equivalents have averaged a return of about 10.6% annually.

Like many of Buffett’s own top holdings, the S&P also offers a decent amount of dividend income. At the time of this writing, the index yields about 1.2%. More importantly, though, dividend reinvestment has been a major driver of cumulative S&P returns. Over the last century, dividends are estimated to have accounted for about 40% of the index’s total return.

Furthermore, as Buffett proved during his bet with Protege Partners, the low-cost nature of modern index funds offers substantial advantages compared to the high fees charged by actively managed funds.

SPY and VOO carry expense ratios of 0.09% and 0.03%, respectively. With hedge funds charging an average of 1.4% in management fees and a further 16.4% in performance fees, it’s not hard to see why the lower costs associated with broad index funds outweigh any advantage actively managed hedge funds might produce.

A final advantage of the S&P 500 is the fact that it limits the risk associated with any one investment. Although Buffett has made his career picking out individual companies and building a concentrated portfolio of those he believes will perform best, he freely admits that picking individual stocks is a complex and potentially risky matter. For most day-to-day investors, therefore, buying index funds represents a way to capture reliable market gains without having to do the kind of research Buffett has done over a lifetime of investing.

What Role Do the S&P 500 Funds Play in Berkshire’s Portfolio?

Taken together, the value of the two index funds held by Berkshire makes the S&P 500 Berkshire’s second-largest stock holding. Apple still outweighs the index in Berkshire’s portfolio at over $84 billion in holdings, but the two funds put together handily outweigh American Express at about $35 billion.

As such, it’s hard to say that the S&P 500 funds Berkshire owns play an insignificant role in its overall investment strategy. Indeed, these holdings would seem to go against Buffett’s own historical instincts of finding a small handful of undervalued companies that have the potential to beat the broader stock market. As such, it’s clear that he must have had a good reason for adding them to the portfolio.

The answer likely comes down to capital allocation and Buffett’s increasing difficulties finding stocks that are both undervalued and large enough for Berkshire to invest substantial amounts of money in. Buffett himself has acknowledged many times that finding investment opportunities has gotten progressively harder as the amount of money Berkshire works with has increased. Today, Berkshire can only make meaningful investments in large-cap companies that tend to be closely watched by the entire market.

This has resulted in Berkshire racking up an enormous reserve of uninvested cash, currently standing at about $277 billion. This reserve has only grown in recent months, especially as Berkshire has unwound a substantial amount of its Apple holdings. Buffett has mostly used the cash to buy a mountain of short-term US Treasury Bills, taking advantage of the currently high yields on bonds.

Holding S&P 500 funds, therefore, could be seen as a way for Berkshire to deploy some of its capital without the ordinary constraints of investing in a single stock. $45 billion would amount to a large share of all but the very largest companies, but it represents a fairly small portion when compared to the total sum of US large-cap stocks. By owning the S&P, Buffett can keep a decent amount of Berkshire’s money at work without the complications of buying tens of billions of dollars worth of individual stocks.

Here, it’s worth noting that Buffett doesn’t actively seem to be putting additional money into the S&P 500. This largely tracks with the fact that one of his well-known indicators for stock market valuation, namely the ratio between total market cap and GDP, strongly suggests that the US stock market is overvalued. As such, Buffett appears to prefer safe returns in government debt instruments to the risks of the stock market at the moment. If stocks become more reasonably priced or interest rates fall back to extremely low levels, though, it’s possible that Berkshire could begin allocating new capital into SPY and VOO again.