(The opinions expressed here are those of the author, a columnist for Reuters.)
By John Wasik
CHICAGO While it is hard to knock the advice of Warren Buffett, whose annual letter to Berkshire Hathaway Inc shareholders recently lofted down from the mountain of capitalism, some of his tips can be tweaked.
Among the many nuggets of wisdom in the Berkshire report was a recommendation from the company's chairman to the trustee of his estate that 10 percent of the cash be invested in short-term government bonds and 90 percent in a "very low-cost index fund (Vanguard's)."
Buffett is spot on about holding onto an index fund and avoiding the exorbitant fees of active managers. But we should look at his advice a bit more closely.
In an earlier Buffett blog on Fortune.com, the legendary investor cited the ticker symbol for the Vanguard 500 Index fund. The fund charges 0.17 percent in annual expenses and owns the top 500 U.S. stocks by market capitalization, such as Apple Inc, Exxon Mobil Corp and Google Inc. As of Friday, it was up about 2 percent year to date.
In line with Buffett's penchant for penny-pinching and focus on long-term returns, I was wondering if you can find a better index fund. You can certainly find a cheaper fund that tracks the Standard & Poor's 500 stock index.
Vanguard's exchange-traded S&P 500 Index fund charges only 0.05 percent annually and trades commission-free through many discount brokers, include Vanguard.
I would also call into question Buffett's selection of the Vanguard 500, which picks a near-static basket of the most popular U.S. stocks, many of which could be overvalued.
What might appeal more to Buffet's bargain-picking acumen would be a fundamental S&P 500 fund like the Guggenheim S&P 500 Equal Weight ETF, which owns roughly equal percentages of stocks in the index, including lesser-known companies like LSI Corp, Harman International Industries and F5 Networks Inc.
Instead of overweighting the most popular stocks the way most S&P 500 funds do, the Guggenheim fund tilts in the favor of lower-priced companies that pay regular dividends. This strategy beat the S&P 500 index for the past decade by almost two percentage points. It is up 3 percent year to date, compared with about 2 percent for the S&P 500, and costs 0.40 percent annually to own.
RELATIVE PERFORMANCE COUNTS
Even though Buffett is recommending them, far too many investors may think index funds are too staid for their tastes. They will want to achieve stellar returns like Buffett has over the past 50 years.
Although it is hard to quibble with Buffett's compounded performance at Berkshire Hathaway - the overall gain is 693,518 percent from 1964-2013 - the big jumps came quite a while ago.
Berkshire now appears to be more index fund-like, at least in terms of overall return. For the last four of the last six years, the stock has underperformed the S&P 500.
Is Buffett losing his swagger? For the sake of clarity, it should be noted that the S&P index returns are pretax, while Berkshire's are after taxes, so Buffett still has the edge in the long term. Still, would it make sense to invest in Berkshire Hathaway now rather than just stay in an index fund?
While most of Berkshire's investors and Buffett's many admirers want to see the chairman live forever, most of his best trades, deals and holdings remain in the past. This despite his statement in the Berkshire annual report that "book value and intrinsic value will outperform the S&P in years in which the market is down or moderately up."
Yet you cannot expect the company, especially under Buffett's still-unnamed successor, to continue its winning ways.
For the interim, most of Buffett's advice is solid, but with some caveats. I would still buy the lowest-cost index fund but would make sure I had a basket of non-U.S. stocks in developed and emerging markets in a total market international fund like the iShares Core MSCI Total International Stock ETF. The fund, which charges 0.05 percent annually in management expenses, tracks an index of non-U.S. stocks like Nestle S.A., Roche Holdings AG and HSBC Holdings PLC.
The same thinking on broad global diversification would apply to my bond holdings for my short-term cash needs - money I need in a year or less - in a short-term Treasury or corporate bond or money-market fund.
I would also want part of my income portfolio in European and emerging-markets bonds, municipal bonds and Treasury Inflation-Protected Securities, high-yield corporate debt and floating-rate notes for inflation protection.
All of this begs for more index fund investing across the board. So you should not mistake Buffett's one gem of advice as a one-stop solution. There is a simple formula behind it, but you need to apply it broadly.
(Editing by Lauren Young and Lisa Von Ahn)