3 Reasons Warren Buffett Loves Vanguard Index Funds

Warren Buffett is famously cheap and he loves U.S. equities.

Therefore it came as no surprise when he gave an explicit nod to Vanguard index funds in the 2013 letter to shareholders of Berskshire Hathaway (NYSE: BRK-B), where he describes how he advises his vast wealth be invested after he dies.

“My advice to the trustee couldn’t be more simple,” Buffett wrote. “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.”warren-buffett

There is no doubt that Buffett likes Vanguard index funds because of their passive nature and low expenses. But it is likely that he specifically mentions an S&P 500 index fund because of its diverse exposure to U.S. equities.

In the recently published 2014 letter to Berkshire shareholders, Buffett reiterated his belief in the future of America, and thus his shameless and steadfast support of investing in US equities.

“Though the preachers of pessimism prattle endlessly about America’s problems, I’ve never seen one who wishes to emigrate (though I can think of a few for whom I would happily buy a one-way ticket),” he stated. “The dynamism embedded in our market economy will continue to work its magic. Gains won’t come in a smooth or uninterrupted manner; they never have. And we will regularly grumble about our government. But, most assuredly, America’s best days lie ahead.”

Combining the elements of investing in America, his reverence to shareholders, his patient, buy-and-hold philosophy and his relentless search for value, it is no surprise that he would love (and recommend) Vanguard funds.

Why Buffett Recommends Vanguard Index Funds

While there is no Vanguard fund that attempts to clone Buffett’s investment style – like some other mutual funds may attempt (and fail) to do – Vanguard index funds are investments he believes are ideal for most investors.

Here’s why:

  1. Vanguard index funds are cheap: All of Vanguard’s funds have expense ratios far below average for mutual funds. For example, the typical stock mutual fund might have an expense ratio of 1.5% or higher, whereas you won’t find one Vanguard fund with an expense ratio higher than 1.0%. And its index funds are commonly five times cheaper at 0.20% or less.
  2. Vanguard index funds offer diverse exposure to US equities: Buffett’s reference to the Vanguard 500 Index (VFINX) fund was likely due to the fact that 100% of the portfolio holdings are stocks of companies based in America. And perhaps a secondary reason for Buffett loving VFINX is that Berkshire is currently the No. 6 holding in the fund.
  3. Vanguard index funds have low turnover: One of Buffett’s most famous quotes is, “If you aren’t willing to own a stock for 10 years, don’t even think about owning it for 10 minutes.” In the mutual fund world, this philosophy is embodied in the idea of low turnover, which is at the core of buy-and-hold investing. The Vanguard 500 Index fund has a turnover ratio of just 5% of the portfolio. All of the top 10 holdings were first bought at least 15 years ago, and many of the fund’s 500 or so holdings have been in the portfolio for more than 30 years.

You don’t have to invest like Buffett to follow his advice. Considering the near-impossible feat of matching or exceeding Buffett’s long-term success, it is much easier for an investor to simply buy shares of Berkshire Hathaway than to attempt imitating the investing style behind it.

Otherwise, as Buffett advises, just buy a Vanguard index fund.

As of this writing, Kent Thune did not hold a position in any of the aforementioned securities. Under no circumstances does this information represent a recommendation to buy or sell securities.

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