Warren Buffett is one of the most influential investors in the world. He started his investing journey at 11 when he bought his first stock. In 2017, he was the third richest person in America, and now he holds thousands of shares of the most important companies in the world. If you are hoping to be a successful investor like Buffett, you maybe want to follow his advice on investing in index funds.
What are index funds?
First of all, we need to understand what an index is.
In simpler words, an index is a measure that calculates changes in a market. There are many indexes over a wide range of markets that help investors get a glimpse of the overall economy.
Now, index funds are a type of investment that replicates the performance of a specific index and its market. So, for instance, if you invest in the Dow Jones index fund, your investment will have a similar performance to the overall US market.
How do index funds work?
Index funds are bundles of stocks that aim to match the performance of a specific index. Each stock represents a small percentage of the entire portfolio, just as in an ETF. They were created under the philosophy of mimicking the market instead of struggling to beat it.
Let’s take a look at an example. Let’s say you want to build up a portfolio that mimics the performance of the Dow Jones Industrial Average. To do that, you would have to invest in some McDonald’s shares, Walt Disney stocks, a couple of Walmart’s, and the rest of the 30 companies in the index, always replicating its ponderations. This means that if, say 5% of the index is made up of Walt Disney stocks, 5% of your portfolio should also have Walt Disney shares.
Index funds have gained popularity as more and more investors are opting for passive investing. This is because, by investing in index funds, you can skip the tedious process of analyzing each stock individually. Instead, you can just buy shares of the fund and let the firm managing it take care of the rest.
Warren Buffett’s recommendations
Warren Buffett suggests that investing in index funds is the best way to grow your money because it is low-cost and straightforward.
According to Jack Bogle, author of The Little Book of Common Sense Investing, Buffett said that “by periodically investing in an index fund, the know-nothing investor can out-perform most investment professionals.” In other words, you don’t need to be a level 100 investor to have good returns with index funds.
Besides working as an excellent low-cost investment opportunity, Buffett states that index funds help boost your retirement savings. In an interview with CNBC’s On The Money Podcast, he recommends: “consistently buy an S&P 500 low-cost index fund, I think it’s the thing that makes the most sense practically all of the time.”
The reason behind Buffett’s recommendation lies around the principles of value investing applied to indices. Generally speaking, it would be a lot easier for a beginner investor to adopt the ‘buy and hold’ practice by investing in index funds and letting their money increase in value over time. After all, investing in a Dow Jones index fund, for example, is the same as investing in the 30 most prominent companies in the US… All at once!
You have probably thought of index funds as an intimidating topic, but we learned that’s not the case. One of the most successful investors in the world, Warren Buffett, highly recommends investing in them. You don’t need to be a professional investor to do so, and it can bring sweet benefits to your investment portfolio.
You can start investing in ETFs that mimic index funds through the FlexInvest platform. It’s one of the easiest and safest ways to put your money to work. However, before you go into that, make sure to check out the rest of the articles in our library to learn more about investing instruments and strategies.