Warren Buffett has always been an advocate of investing in S&P 500 index funds, even going so far as to plan for 90% of his remaining fortune to be put into such funds after his death for his wife. Surprisingly, though, Buffett recently sold the only two S&P 500 index funds owned by his Berkshire Hathaway conglomerate.
These two funds, one from Vanguard and one from State Street Global Advisors, had made up an extremely small part of Berkshire’s holdings. Why did Buffett sell the S&P 500, and does this mean that S&P 500 funds are no longer a good investment in today’s market?
Buffett Almost Certainly Believes US Stocks Are Overvalued
Perhaps the most obvious reason for Buffett’s sale of his two S&P 500 index funds is the fact that he believes American stocks have become overpriced. Owning an S&P 500 fund, more than one-third of any investor’s money is currently in highly-valued tech stocks like Tesla, NVIDIA and the other Magnificent Seven companies. Even with a very small position like the one Buffett had, he may not have liked the idea of having Berkshire Hathaway’s money tied up in overvalued assets.
Buffett’s restrained buying activity over the last couple of years could speak volumes about how he thinks of current stock prices. Buffett has made relatively few new investments while pulling large parts of his portfolio back to a cash reserve that now exceeds $320 billion.
Even more important is the current status of the so-called “Buffett Indicator,” long known to be the Oracle of Omaha’s favored metric for assessing the valuation of American stocks as a whole. This indicator measures the total market capitalization of publicly traded US equities against the nation’s GDP. The historical average of this ratio is about 0.67, meaning that the stock market’s capitalization represented about two-thirds of GDP. Today, the ratio is 2.11, more than twice the historical average.
Perhaps the single biggest indicator that Buffett thinks the market has become too pricey is the fact that he has stopped buying back shares in his own company. In 2018, Buffett was given broad authority to buy back Berkshire shares.
Following that change, he and his then-partner Charlie Munger spent the next six years aggressively buying Berkshire shares whenever they believed the stock was trading below its intrinsic value.
Since May of last year, though, Buffett hasn’t taken the opportunity to repurchase any Berkshire shares. This suggests that even his own company could have become too expensive for his tastes.
The S&P 500 Position Was a Tiny Drop in Berkshire’s Bucket
The second very real possibility is that Buffett decided the two S&P 500 index fund investments were simply too small to bother with.
At only 0.02% of the total Berkshire portfolio, the S&P 500 holdings had effectively no ability to impact the company’s total investment performance. Irrespective of whether the funds tanked or skyrocketed, their returns would be all but meaningless compared to the rest of Berkshire’s positions.
Buffett is also known to be a believer in portfolio concentration. Allocating large amounts of capital into a few really good companies, Buffett believes, is better than spreading small amounts around into a much larger number of investments that may not perform as well. As such, having a pair of funds that made up such a tiny amount of Berkshire’s portfolio may have made little sense in Buffett’s mind.
So Why Did Buffett Sell the S&P 500?
While either one of the explanations outlined above could justify Buffett’s sale of his S&P 500 index funds, there’s a good chance that both are true at once. Buffett, known for maintaining a concentrated portfolio, likely wouldn’t have had much ongoing use for such tiny positions. Given that he has been pulling back to cash for some time in anticipation of future buying opportunities, selling them would have presented itself as a sensible solution.
The one alternative to selling the S&P positions would have been to expand them, but the overvalued nature of the American stock market would probably have made this option unattractive to Buffett as a value investor. Combined, these two factors would likely have made selling the funds the best approach from Berkshire’s point of view.
Does This Mean S&P 500 Index Funds Have Become a Bad Investment?
While the S&P 500 is likely overvalued at the moment, Buffett’s decision to sell doesn’t mean that the index has ceased to be a good investment. Even though the figure is below the S&P 500’s historical average, Goldman Sachs projects that the index will produce a cumulative return of about 6% a year through 2030.
It’s also worth noting just how well the index has performed over the last few years, the majority of which has been spent well above the historical average of the Buffett Indicator. Even with the current market correction taken into account, the S&P has returned 11.1% on an annualized basis over the last three years and 14.2% over the last five years.
A final argument in the S&P’s favor is the fact that the index has been a reliable historical producer of dividend income. Even with the low yields resulting from today’s elevated prices, the index as a whole still yields 1.3%. For individual investors planning for eventual retirement, this makes the index a potentially attractive source of both growth and a certain amount of regular income.
So, while the two small S&P 500 fund positions Buffett recently sold off may not have been a good fit for the Berkshire portfolio, the index itself is still likely the best passive investment for building wealth over the long run. Those looking for reliable investment opportunities are still likely to do well in a low-cost S&P 500 index fund over many years. Buffett’s situation and strategy are somewhat unique, so his selling decisions on his two S&P 500 funds likely have little bearing on the efficacy of those funds for average retail investors.
The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.
