A few months ago, Warren Buffett got a rise out of the financial media and delivered some serious Investing 101 material by outlying his plans for the financial care of his wife after his passing.
So, what did he suggest? All-in on Berkshire Hathaway (BRK.B)? Hardly. Diversified portfolio of some of his favorite holdings? Nope.
Index, baby, index!
From the Oracle himself:
“My advice to the trustee could not be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. (I suggest Vanguard’s.) I believe the trust’s long-term results from this policy will be superior to those attained by most investors — whether pension funds, institutions or individuals — who employ high-fee managers.”
The biggest takeaway, of course, was that one of the world’s greatest investors just gave one of the loudest-ringing endorsements possible for simple index funds. Everyone covered that news ad nauseam (guilty), and well they should have — there are few better pieces of advice for newbie investors than to hunker into diversified, cheap funds.
But investors paying attention to the details got another wise piece of investing advice in Buffett’s parenthetical: “I suggest Vanguard’s.”
Of course Warren Buffett suggested the big kahuna of Vanguard index funds. The man loves himself a deal.
Whether Buffett meant the Vanguard S&P 500 ETF (VOO) or the mutual funds (VFINX) is up for debate. But what isn’t up for debate is that Vanguard is one of the fund world’s leading providers of diversification on the cheap.
And cheap, while not everything, is important — especially if you don’t have much to invest with.
Why Vanguard Funds’ Low Cost Matters
Funds — whether mutual or exchange-traded — charge certain fees to keep the lights on, pay advisers, tackle building rent, you name it. Everyone does it, even Vanguard.
But Vanguard has an unorthodox structure in that the company technically is owned by the very funds it offers, and so by proxy, it’s owned by anyone and everyone who owns any of those funds. And thus, the company has a pretty obvious motivation to keep Vanguard funds so cheap: It keeps the owners happy!
That’s because those fees do add up.
Let’s say you have $10,000 to invest and you throw it all into a fund that charges 1% in expenses. That means for every $10,000 you invest, $100 of it isn’t going toward your investment — it’s going toward paying the fund company. If you could only pay $50 for every $10,000 and get virtually the same result, you’d want to, right?
Sure. And it’d be nice just to have the extra $50 on its own. But if you’re investing for the long haul, $50 can end up being a lot more than $50. Let’s say you average 7% returns annually. Over a period of 40 years, that one $50 saved in $10,000 invested adds up to almost $750.
Now let’s say you add $5,000 to your investment every year? The difference in fees between those two funds adds up to more than $6,000.
Will six grand be the difference between a happy retirement and a miserable one? Of course not — but piling up lots of small victories like that along the way will be the difference.
One thing to keep in mind is that Vanguard funds don’t always offer the lowest fees for what you’re looking for. Sometimes it’ll be two of the other “big three” providers — BlackRock’s (BLK) iShares, sometimes it’ll be State Street’s (STT) SPDRs. And sometimes it’ll even be Charles Schwab (SCHW), who has a laundry list of uber-cheap ETFs but doesn’t necessarily get the publicity that it deserves for that.
But Vanguard funds haven’t gotten their reputation for nothing, and Warren Buffett, of all people, knows that every basis point can add up.
That’s why the Oracle gave Vanguard funds the nod.