The Motley Fool

Why Warren Buffett Says You Should Buy Tracker Funds

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It may be somewhat surprising for one of the world’s most successful investors to be positive about tracker funds. After all, Warren Buffett has made $billions from investing in a relatively small number of companies that have outperformed the S&P 500 over a long time period.

However, for some people Buffett thinks a tracker fund could be a better idea than investing in a portfolio of stocks. It provides the opportunity to generate a relatively high return over the long run, as well as a high degree of diversity.

Of course, beating the market is still be possible for those investors who wish to follow in the footsteps of Buffett himself. With global stock markets having come under pressure of late, there may be greater opportunity to do so at the present time.

Tracker fund appeal

Tracker funds aim to mimic the performance of a specific index. Although there is tracking error that means their performance may not perfectly match that of the S&P 500 or FTSE 100, for example, over the long run they generally offer a representative performance of a particular index.

This provides investors with simple and cost-effective access to the stock market’s returns. Over the long run, they are likely to be in the high-single digits on an annualised basis. When compounded, this can lead to a surprisingly high return that ultimately catalyses your retirement prospects.

Furthermore, tracker funds offer a large amount of diversity that helps to reduce overall risk. Their low costs and the simplicity of investing in them means that they are a worthwhile product for any time-poor investor who does not wish to engage in a process of unearthing undervalued stocks that could beat the wider market.

Outperformance potential

Warren Buffett’s track record shows that it has been hugely beneficial for him to buy specific stocks, rather than invest in a tracker fund. He has outperformed the S&P 500 over many decades, and in doing so has amassed a vast portfolio in terms of its value.

While not every investor may be able to outperform the wider stock market to the same extent as Warren Buffett has, it is possible for almost any investor to beat the performance of tracker funds. Following Buffett’s strategy of buying high-quality businesses while they trade at fair valuations could make this task easier. Furthermore, buying stocks when other investors are fearful could be a means of maximising your potential to generate capital growth.

Clearly, it may not be possible to achieve beat the wider index in every month or year. However, over the long run a value investing strategy that seeks to use the cyclicality of the stock market to your advantage could lead to relatively high returns. As such, while tracker funds are appealing from a risk/reward perspective, beating the stock market is an achievable goal that could transform your financial future.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

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