Where I Disagree With Warren Buffett

May 22, 2017

I’m most definitely a Warren Buffett fan. I love it that arguably the most successful active investor alive recommends index funds, long holding periods and minimizing fees. And I love that Buffett walks his talk about being greedy when others are fearful.

During the real estate/financial collapse, for instance, he was buying more stocks while the vast majority of Wall Street was dumping them faster than rotten food. Still, even a fan like me might have a point or two with which I take issue.

Investors Should Own S&P 500 Index Funds

Warren Buffett often extols the many merits of the S&P 500 Index fund. In the most recent Berkshire Hathaway Annual Report, Buffett reveals the data on his 10-year bet that the S&P 500 Index total return would best hedge funds. With nine of the 10 years now history, let’s just say the hedge fund managers are losing in a rout.

Buffett often recommends the S&P 500 Index fund, but why? It’s flawed in a couple of respects. First, it misses out on the thousands of U.S. companies not in the S&P 500. I’m a dumb-beta investor, as factors such as size and value are no free lunch—the excess expected return is compensation for taking on more risk. This is not to say I want to ignore small and midsize companies.

The second flaw of an S&P 500 Index fund is its popularity. Any new entrant to the S&P 500 Index comes at an inflated price. Every S&P 500 Index fund will buy only after the price has gone up, since investors inflate the price knowing billions of dollars of the stock must be purchased when a company is added. Conversely, any company being booted from the S&P 500 Index will likely suffer a price decline before the S&P 500 Index fund dumps it.

Thus, a total stock index fund is better—it’s just as low cost, and even more tax efficient. And while we’re at it, why stop at the U.S.? Global economy and international stock index funds have a role as well.

 

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