Since buying his first stock at age 11, Warren Buffett has amassed a fortune of $90 billion and has become one of the most recognizable figures in finance. Buffett’s ability to pick winning investments is simply exceptional, and Berkshire Hathaway (BRK.A -0.59%) (BRK. B -1.13%) achieved immense success under his leadership. In fact, between 1964 and 2021, Berkshire stock soared more than 3,600,000%, and as of June 30, 2022, Buffett had amassed more than $177 billion in unrealized gains from Berkshire’s portfolio.
With testimonials like this, it’s no surprise that Buffett has become a legend in his day. More than 40,000 people flock to Nebraska each year to attend Berkshire’s annual shareholder meeting, eager to hear Buffett — known as the “Oracle of Omaha” — his thoughts on investment philosophy and the broader economy.
Of course, Buffett has shared a lot of wisdom over the years, but one piece of advice is particularly relevant right now.
Warren Buffett made a big bet (and won) in 2007
Buffett challenged the investing world in December 2007. He bet $500,000 that no professional investor could pick a set of five hedge funds — actively managed investment products with high fees — that would outperform passively managed ones S&P500 index funds over the next 10 years.
Only one consulting firm, Protégé Partners, took up this challenge. The company hired five professional investors (each employing dozens of investment professionals) to manage one hedge fund apiece. In total, Protégé had more than 200 hedge fund managers looking to beat Buffett.
The bet began in January 2008 — when the S&P 500 collapsed under the weight of the Great Recession, an event that ultimately wiped out 56% of its value — and ran through December 2017. Buffett emerged victorious, and he won by a wide margin. The S&P 500 returned 125.8% over the period, while the top-performing protégé fund returned just 87.7%. It’s worth noting that the worst-performing protégé fund performed so poorly that it was liquidated in 2017.
An S&P 500 index fund is a great option for most investors
Investors can learn a lot from this story. Buffett beat hundreds of highly qualified professional investors, and he beat them without doing anything. A passively managed S&P 500 index fund simply mirrors the composition (and therefore tracks performance) of the S&P 500. Meanwhile, Protégé had hundreds of hedge fund managers actively buying and selling investments during the 10-year period. You worked a lot and got a worse result.
This anecdote explains why Buffett has consistently recommended a low-cost S&P 500 index fund for most investors. In 2017, he urged investors to “keep buying [an S&P 500 index fund] through thick and thin and above all through thin.”
This advice is still relevant today – especially relevant in this challenging environment. High inflation and rising interest rates have crashed the stock market, and the S&P 500 is currently 25% off its peak. That puts the index in a bear market, or a clear example of the “thin” times Buffett mentioned earlier, and investors would do well to heed Buffett’s advice regarding an S&P 500 index fund.
Another option for investors
Over the past decade, Berkshire Hathaway’s stock has virtually mirrored the performance of the S&P 500. But Berkshire’s stock has a five-year beta of 0.89, meaning it tends to rise and fall less dramatically than the broader market. That makes Berkshire stock a reasonable investment option for Buffett fans who find an S&P 500 index fund a little too volatile.
Berkshire has built a number of companies operating in several critical industries, including insurance company GEICO, railroad operator Burlington Northern Santa Fe, and industrial specialists Precision Castparts and Lubrizol. Berkshire also owns 92% of Berkshire Hathaway Energy, which itself has several subsidiaries involved in electric and natural gas utilities.
This diversification makes Berkshire financially resilient. Case in point: The company has grown free cash flow per share at a 6% annual rate for the past 15 years, despite surviving a couple of downturns during that time. Of course, no company is immune to an economic downturn, but Berkshire’s resilience is an advantage in the current environment.
In addition, the company has over $105 billion in cash and short-term investments on its balance sheet. This war chest leaves Buffett with plenty of capital to use should he find cheap investments in the bear market.
Of course, investors don’t have to choose between an S&P 500 index fund and Berkshire. It’s okay to own both — I doubt Buffett would turn down that.
Trevor Jennewine has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Berkshire Hathaway (B shares). The Motley Fool recommends the following options: long January 2023 $200 calls on Berkshire Hathaway (B shares), short January 2023 $200 puts on Berkshire Hathaway (B shares), and short January 2023 $265 calls on Berkshire Hathaway (B shares). The Motley Fool has a disclosure policy.